Untitled

Energy Regulatory Compliance:
The Skadden Handbook
Courtesy of
Skadden
Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates
Key Compliance Team Members
Mike Naeve
Former FERC Commissioner
(202) 371-7070 mnaeve@skadden.com
Jerry Richman
Ten-year veteran of FERC Enforcement Staff, conducting audits and investigations
(202) 371-7232 grichman@skadden.com
David Hill
Veteran litigator experienced at defending FERC and other agency audits and investigations
(202) 371-7259 djhill@skadden.com
Bill Scherman
Former FERC General Counsel
(202) 371-7060 wscherma@skadden.com
John Estes
Litigator and former FERC staffer
(202) 371-7950 jestes@skadden.com
Dana Freyer
Worked with more than 250 companies on design and implementation of compliance and ethics programs
(212) 735-2506 dfreyer@skadden.com
We believe our depth of experience and ability to serve our clients in the FERC compliance practice area is unrivaled. We encourage you to contact us.
Noel Symons
Principal author, EEI computer-based training on Standards of Conduct
(202) 371-7166 nsymons@skadden.com
SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP 1440 NEW YORK AVENUE, N.W. WASHINGTON, DC 20005-2111 (202) 371-7000
Energy Regulatory Compliance: The Skadden Handbook
Copyright 2005 Skadden, Arps, Slate, Meagher & Flom LLP. All Rights Reserved.
This publication is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This publication may be considered advertising under applicable state laws.
Contents
The Importance and Structure of Compliance Programs
Introduction The Growing Importance of Compliance Programs for Energy Companies Chapter 1 The Hallmarks of a Successful Compliance Program
Compliance with FERC-Administered Statutes

A. In General Chapter 2 FERC Audits and Investigations Chapter 3 Civil and Criminal Penalties Under the Federal Power Act Chapter 4 FERC Reporting Requirements B. FPA Section 203 Chapter 5 Mergers, Acquisitions and Reorganizations C. FPA Section 204 Chapter 6 Issuance of Securities and Assumption of Liabilities D. FPA Section 205 Chapter 7 Power Sales and Related Jurisdictional Transactions Chapter 8 Transmission and Interconnection Service Chapter 9 Market Behavior Rules Chapter 10 Standards of Conduct for Transmission Providers Chapter 11 Codes of Conduct E. FPA Section 305 Chapter 12 Interlocking Directorate Rules F. FPA Part I Chapter 13 An Overview of Hydropower Regulation G. PURPA Chapter 14 The Regulation of Qualifying Facilities H. PUHCA 2005 Chapter 15 Exempt Wholesale Generators
FERC-Regulated Entities
A. Reliability Organizations Chapter 16 Reliability Standards and Practices B. Organized Markets: Regional Transmission Organizations Chapter 17 Regional Transmission Organization and Market Monitor Requirements
Other Federal Agencies

A. Commodity Futures Trading Commission Chapter 18 Energy Regulation by the Commodity Futures Trading Commission B. Department of Justice Chapter 19 Antitrust Enforcement
Records Retention
Chapter 20 Records Retention
Handbook Updates
Addendum 1 Chapter Updates (March 20, 2006) Chapter 2 FERC Audits and Investigations Chapter 3 Civil and Criminal Penalties Chapter 9 Market Behavior Rules Chapter 12 Interlocking Directorate Rules Chapter 14 The Regulation of Qualifying Facilities Under PURPA Chapter 16 Reliability Addendum 2 Alert for QFs (April 6, 2006)
Introduction The Growing Importance of Compliance Programs for Energy Companies

The regulation of electric companies has undergone a sea change in the past twenty years. During this period, Congress and the Federal Energy Regulatory Commission ( F E R C )h a v el o w e r e dr e gulatory barriers to new entry in the generation business, authorized sales of electricity at market based-rates, required vertically integrated utilities to provide transmission service on an open-access basis, ordered utilities to functionally separate their transmission and generation businesses, and encouraged the formation of Regional Transmission Organizations. State legislatures and commissions also have adopted significant reforms. Between 1996 and 2000, twenty-five states adopted retail access legislation, allowing retail customers to choose their supplier. Many of these jurisdictions also encouraged generation divestiture, which in turn further stimulated competition at the wholesale level. Taken together, these federal and state law changes have transformed an industry previously characterized by vertical integration and cost-based regulation into one characterized by vertical disaggregation (whether functional or structural) and deregulated energy sales. This marked shift in regulation and industry structure has created new opportunities for energy companies, but it also has created significant new legal risks, particularly at the federal level. In the old days, regulated companies would interact with FERC mainly when the company filed a rate case or a merger application, events that often were episodic. Today FERC has moved beyond the regulation of services to focus more on the regulation of behavior not just of companies but of numerous individuals, ranging from senior officers and directors to operating employees to support personnel. Chairman Kelliher recently echoed this perspective when he stated: [ T ] h eC o m m i s s i o n sr o l eh a sc h a n g e df u n d a m e n t a l l ya sa r e s u l to f dynamic changes in the electricity industry. . . . Instead of setting rates for individual sellers and individual transmitting utilities, the Commission increasingly establishes rules of general application that regulate markets by enforcing market rules. I na b r o a ds e n s e , t h e C o m m i s s i o n s r o l e h a s s h i f t e dt ob e c o m e m o r e l i k e other federal economic regulatory agencies, such as the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). Those agencies discharge their legal duties by setting rules of general application that regulate the commodity and securities markets, respectively. 1
Joseph T. Kelliher, Market Manipulation, Market Power, and the Authority of the Federal Energy Regulatory Commission, 26 ENERGY L.J. 1, 14-15 (2005).
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK
Congress recently accelerated this paradigm shift by giving FERC broad new civil penalty authority for violations of the Federal Power Act up to $1 million per day per violation. In the wake of these changes, FERC has issued its new Enforcement Policy Statement, stating that it is prepared to use its full civil penalty authority as circumstances warrant and also may refer cases for criminal prosecution (which may result in jail sentences). Certainly FERC has the resources to follow through on this warning. Over the last several years it has beefed up its enforcement resources, creating a separate division, the O f f i c eo f Ma r k e t O v e r s i g h t a n dI n v e s t i g a t i o n s( O MO I ) , t op e r f o r mi n v e s t i g a t i o n sa n d audits of regulated companies. OMOI today has over 100 staff members and has initiated investigations and audits on a wide range of issues. R e f l e c t i n gt h e o v e r a l l m a t u r a t i o no f F E R C s e n f o r c e m e n t f u n c t i o n , t h e Enforcement Policy Statement does not simply rattle sabers. It also sets out a series of mitigating factors, drawn in part from the experience of other federal agencies, that FERC may apply to reduce penalties. Chief among these is the existence of an effective compliance program. The message is clear: from now on companies without strong, comprehensive compliance programs will suffer higher penalties for violating FERC requirements. And given F E R C s dramatically expanded penalty authority, the stakes are higher than ever. The risk of failing to comply with F E R C s r u l e s t h u s is quite serious, yet compliance is not a simple matter. Any given company may have hundreds of employees that could create compliance issues, not only through rogue behavior but also through sheer i n a d v e r t e n c e .A n dm a n yo fF E R C sr u l e s are framed in fairly general terms, creating substantial compliance challenges. It is no small task to manage the resulting risks. The Handbook is designed to help electric companies respond to these new challenges by developing an effective compliance program. In addition to discussing compliance with specific areas of FERC regulation, we outline an overall approach for e s t a b l i s h i n g a c o m p l i a n c e p r o g r a mt h a t d r a w s n o t o n l y o n F E R C s r e c e n t Enforcement Policy Statement but also on the Federal Sentencing Guidelines for Organizations, which FERC relied on in crafting its enforcement policy. Now for the fine print. The Handbook does not represent legal advice and does not attempt to cover every topic in detail. Instead it seeks to outline the major compliance challenges associated with certain core areas of FERC regulation in sufficient detail to allow corporate counsel to identify the types of behavior and transactions that can trigger regulatory issues. It is, of course, vital that every compliance program be tailored to the company in question, and that the company track regulatory developments, adjusting its compliance measures as needed over time. Hopefully the Handbook will provide a valuable starting point for such efforts. In addition, as we were finalizing the Handbook, FERC launched several new initiatives that have significant implications for FERC compliance and enforcement matters. We have attempted to reflect these late-breaking developments where possible, but that effort obviously must cease at some point. We do, however, intend to update the Handbook periodically and may add new topics. As you review the Handbook we would appreciate any feedback you might have, including additional topics you would like to see addressed.
INTRODUCTION
iii
Please feel free to contact any of the lawyers involved in the Handbook with suggestions, or for legal advice regarding specific questions or transactions. Several of the key lawyers who focus on compliance, enforcement and audit matters are listed on the inside of the front cover. In closing, we want to thank the numerous people who spent countless hours working on this project. The authors of specific chapters are listed within their chapters. In addition, several editors merit special mention. Noel Symons took a leadership role from the start, not only as an editor but also as an overall driving force. John Shepherd worked tirelessly on all aspects to create a finished product. Kathleen Barrn, Alex Cooke, David Hill, Donna Francescani, Jerry Pfeffer and Jerry Richman each discharged significant editing responsibilities. And legal assistants Anne Applebaum and Kristen Miller pitched in cheerfully on many fronts to keep the project on track. We hope you find the results useful.
John Estes
Mike Naeve
Bill Scherman
Chapter 1 The Hallmarks of a Successful Compliance Program

DANA H. FREYER As discussed in the Introduction to this Handbook, the move in recent years by state and federal regulators toward more competitive, more efficient energy markets has in turn fostered a sea change in the manner of regulation. Regulators who previously set prices are allowing regulated entities to set their own prices. Having foregone the direct regulatory tools at their disposal, regulators increasingly are turning to indirect behavioral rules that establish parameters for conduct, allowing the regulated entities to move freely within the confines of those parameters. These rules are much more invasive than prior regulation, meaning that establishing and maintaining compliance is more difficult than ever before. Indeed, many electric companies have yet to bridge this gap and step up their compliance programs to meet the increased demands of FERC regulation. At the same time, the year 2005 has seen two major developments that greatly increase the prudence of having a strong 1 c o m p l i a n c ep r o g r a m .F i r s t , t h eE n e r g yP o l i c yA c t o f 2 0 0 5( E P A ct 2 0 0 5 ) significantly increased criminal and civil penalties for violations of FERC-administered statutes.2 Second, FERC announced a new policy on enforcement its Enforcement Policy Statement3 which f o rt h ef i r s tt i m es e t so u tf a c t o r st h a tF E R Cw i l l c o n s i d e rt og i v e c r e d i t f o rs t r o n g compliance programs, and thereby potentially mitigate the high penalties otherwise permitted under FERC s expanded authority. The Enforcement Policy Statement is a tremendous step for an agency that has, at times, been criticized for the lack of a clear enforcement policy. Among other things, by
P a r t n e r , S k a d d e n , A r p s , S l a t e , Me a g h e r& F l o mL L P . Ms . F r e y e rh e a d sS k a d d e n s Corporate Compliance Program practice as well as its Arbitration and Alternative Dispute Resolution practices. In addition to her work as an arbitrator and in structuring dispute resolution alternatives to litigation, Ms. Freyer has worked with more than 250 companies in diverse industries on the design and implementation of their ethics and compliance programs, including their training programs and monitoring and auditing systems.
1 2
Pub. L. No. 109-58, 119 Stat. 594 (2005).
A s d i s c u s s e di nC h a p t e r 3 , F E R C s c i v i l p e n a l t ya u t h o r i t yw a s b r o a d e n e dt oe n compass violations of any provision of Part II of the Federal Power Act, or rules, regulations, or orders thereunder, and the potential penalties were increased to up to $1 million per day per violation. See EPAct 2005 1284(e), 119 Stat. at 980 (amending 16 U.S.C. 825o-1). The potential penalties for violations referred to the Department of Justice for criminal prosecution were likewise greatly increased. See id. 1284(d), 119 Stat. at 980 (amending 16 U.S.C. 825o(a)). Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on E n f o r c e m e n t , 1 1 3 F E R C 6 1 , 0 6 8 , a t P P2 , 2 2 ( 2 0 0 5 ) ( Enforcement Policy Statement ) .
3
providing an incentive for utilities to have strong compliance programs, FERC has transformed its compliance relationship with regulated entities from one that is adversarial to one that should prove more cooperative. Nevertheless, the Enforcement Policy Statement provides only general guidance on the types of factors that FERC will consider in imposing penalties and this new policy has not yet been tested through application. Notably, however, in adopting the Enforcement Policy Statement, FERC was guided by parallel experiences in other regulated areas. In particular, FERC alluded to the Federal 4 Sentencing Guidelines for Or g a n i z a t i o n s ( G u i d e l i n e s ) . The Guidelines take into account, in determining punishment for criminal conduct, whether and to what extent a company, through a compliance program, sought to prevent the breach in question. 5 FERC s policy on enforcement echoes this theme, stating that consideration will be given for steps taken to prevent, monitor, and immediately stop misconduct, to report violations to FERC, and to cooperate with FERC s enforcement actions. 6 Thus, experience applying the Guidelines criteria for an effective compliance program should prove helpful to an understanding of FERC s new policy. Moreover, in the event that FERC refers a matter to the Department of Justice ( DOJ ) for potential criminal prosecution,7 DOJ will apply the Guidelines in assessing the company s compliance program. Accordingly, both the Enforcement Policy Statement and the Guidelines could be the basis for assessment of a compliance program in an enforcement action, and we discuss both here. I. FERC S ENFORCEMENT POLICY STATEMENT
In determining the amount of a proposed penalty it intends to impose for violations of t h es t a t u t e si ta d m i n i s t e r s , F E R Ci sd i r e c t e db ys t a t u t et o take into consideration the seriousness of the violation and the efforts of such person to remedy the violation in a timely 8 manner. The Enforcement Policy Statement addresses both of these factors in turn, highlighting the paramount importance of strong internal compliance programs in reducing the potential penalty a company may receive. It begins by listing several questions FERC will consider in assessing the seriousness of a violation9 and then provides a more expansive
Id. at P 8. The Guidelines were promulgated as Chapter 8 of the U.S. Sentencing G u i d e l i n e s Ma n u a l ( U S S G ) . The current edition of the USSG, last amended in November 2004, is found at http://www.USSC.gov/2004guid/gl2004.pdf. See USSG 8C2.5(f)(1) (scoring culpability); id. 8D1.4(c)(1) (probation factors). FERC also drew upon similar standards adopted by the Securities and Exchange Commission ( S E C )a n dt h eC o m m o d i t yF u t u r e sT r a d i n gC o m m i s s i o n( C F T C ) . See Enforcement Policy Statement at PP 7, 9-1 0 . T h e S E C s s t a n d a r d s , w h i c h a d d r e s s t h e a d e q u a c y o f a c o m p l i a n c e p r o g r a m , in turn refer to the Guidelines.
6 7 5 4
Enforcement Policy Statement at P 21.
Enforcement Policy Statement at P 15 (discussing the circumstances under which FERC will refer a matter to DOJ for criminal prosecution). 16 U.S.C. 825o-1(b) (setting penalties for violations of the Federal Power Act); 15 U.S.C. 717t-1(c) (setting penalties for violations of the Natural Gas Act). F a c t o r s e x a m i n e du n d e r t h e s e r i o u s n e s s p r o n go f t h eC o m m i s s i o n s a n a l y s i s i n c l u d e the following: harm caused by the violation; benefit the wrongdoer gained from the violation;
9 8
HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM
l i s t o f q u e s t i o n s F E R Cw i l l c o n s i d e r i n d e t e r m i n i n g w h e t h e r t o g i v e a v i o l a t o r c r e d i t f o r t h e 10 c o m p a n y s c o m m i t m e n t t oc o m p l i a n c e . This commitment is measured in three ways, as set forth below. First, declaring that internal compliance is an important proactive tool,FERC considers these factors: Does the company have an established, formal program for internal compliance? Is it well documented and widely disseminated within the company? Is the program supervised by an officer or other high-ranking official? Does the compliance official report to or have independent access to the chief executive officer and/or the board of directors? Is the program operated and managed so as to be independent? Are there sufficient resources dedicated to the compliance program? Is compliance fully supported by senior management? For example, is senior management actively involved in compliance efforts and do company policies regarding compensation, promotion, and disciplinary action take into account the relevant employees compliance with FERC regulations and the reporting of any violations? How frequently does the company review and modify the compliance program? How frequently is training provided to all relevant employees? Is the training sufficiently detailed and thorough to instill an understanding of relevant rules and the importance of compliance? In addition to training, does the company have an ongoing process for auditing compliance with FERC regulations? How has the company responded to prior wrongdoing? Did it take disciplinary action against employees involved in violations? When misconduct occurs, is it a repeat of the same offense or misconduct of a different nature? Does the company adopt and ensure enforcement of new and more effective internal controls and procedures to prevent a recurrence of misconduct?11
whether the action was willful, manipulative, deceitful, or part of a broader scheme; whether the w r o n g d o e r a c t e di nc o n c e r t w i t ho t h e r s ; t h ec o m p a n y sh i s t o r yo f v i o l a t i o n s ; t h ed u r a t i o no f t h e wrongdoing; senior management awareness of the wrongdoing; whether there was a cover-up; and the effect of potential penalties on the financial viability of the company that committed the wrongdoing. Id. a t P2 0 .R e g a r d l e s so f a n yo t h e r f a c t o r , v i o l a t o r s w i l l b ee x p e c t e dt od i s g o r g eu n j u s t p r o f i t s w h e n e v e r t h e y c a n b e d e t e r m i n e d o r r e a s o n a b l ye s t i m a t e d . Id. at P 19. Furthermore, some conduct m a y b e s oe g r e g i o u s t h a t t h e f u l l u s e o f t h e C o m m i s s i o n s p e n a l t y a u t h o r i t yi s n e c e s s a r y r e g a r d l e s s o f t h e p r e s e n c e o f o t h e r f a c t o r s . Id. at P 18.
10 11
Id. at P 22. Id.
Second, FERC places emphasis on self-correction and self-reporting, noting that the companies themselves are in the best position to detect and correct violations,and that FERC expects companies to be proactivein this regard.12 The Enforcement Policy Statement lists the following factors that will be considered in evaluating whether a violator should receive credit for remedying a violation and reporting it to FERC: How did the company uncover the misconduct? Was it through a self-evaluation, internal audit, or internal compliance program? Did the company act immediately when it learned of the misconduct? Did the company notify FERC promptly? Did senior management actively participate and encourage employees to provide information to identify the misconduct? Did the company take immediate steps to stop the misconduct? Did it implement or create an adequate response to the misconduct? Did the company arrange for individuals with full knowledge of the matter to meet with FERC enforcement staff? Did the company present its findings to FERC and provide all relevant evidence regarding the misconduct, including full disclosure of the scope of the wrongdoing; the identity of all employees involved, including senior executives; the steps taken by the company upon learning of the misconduct; communications among involved employees; documents evidencing the misconduct; and measures taken to remedy the misconduct?13 The final element that FERC will consider when determining whether to give a violator creditfor its commitment to compliance is cooperation. Though FERC deems cooperation to be the duty of any regulated company, it is prepared to give some consideration to exemplary cooperation, that is, cooperation which quickly ends wrongful 14 conduct, determines the facts, and corrects a problem. Further, such cooperation must come early in the process, and no credit will be given if a company does no more than the minimum, or delays cooperation, or purports to cooperate but actually . . . impedes the 15 FERC s activities or consumes FERC resources unnecessarily. The Enforcement Policy Statement lists six groups of factors FERC will consider in assessing whether credit should be given for cooperation: Did the company volunteer to provide internal investigation or audit reports relating to the misconduct? Did the company hire an independent outside entity to assist the company s investigation?
12 13 14 15
Id. at P 24. Id. Id. Id.
Did senior management make clear to all employees that their cooperation has the full support and encouragement of management and the directors of the company? Did the company facilitate FERC access to employees with knowledge and information bearing on the issue, and actively encourage such employees to provide FERC with complete and accurate information? Did the company identify culpable employees and assist FERC in understanding their conduct? Did the company make records readily available, with assistance on searching and interpreting information in the records? Did the company fairly and accurately determine the effects of the misconduct, including identifying the revenues and profits resulting from the misconduct and the customers or market participants adversely affected by the misconduct?16 II. THE FEDERAL SENTENCING GUIDELINES FOR ORGANIZATIONS
While FERC s Enforcement Policy Statement is new, its origins are not. The Guidelines have long emphasized the steps an entity should take to prevent unlawful conduct. In the absence of an established body of law interpreting FERC s new policy, the next best source of guidance is the same materials that FERC looked to in developing its policy, and presumably will continue to look to in interpreting and refining its policy: the Guidelines criteria for an effective compliance program and their application. Prior to the development of the general federal sentencing guidelines, judges could give a defendant (individual or organization) a sentence that ranged anywhere from probation to the maximum penalty for the offense. After several years of research and debate, Congress decided that (1) the previously unfettered sentencing discretion accorded federal trial judges needed to be structured; (2) the administration of punishment needed to be more certain; and (3) specific offenders (e.g., white collar and violent, repeat offenders) needed to 17 be targeted for more serious penalties. FERC s Enforcement Policy Statement likewise is
Id. F o r a d i s c u s s i o n o f c o o p e r a t i o n i n t h e c o n t e x t o f a F E R Ca u d i t o r i n v e s t i g a t i o n , see Chapter 2 of this Handbook.

16
U n i t e dS t a t e sS e n t e n c i n gC o m m n ,An Overview of the United States Sentencing Commission at 1-2, http://www.ussc.gov/general/USSCoverview.pdf.

17
intended to provide greater certainty, 18 and FERC has made it clear that repeat offences will weigh against any credit a company might otherwise receive. 19 The original Federal Sentencing Guidelines were promulgated in 1987. The Federal Sentencing Guidelines for Organizations were promulgated four years later and incorporated as Chapter 8 of U.S. Sentencing Guidelines Manual. 20 As a result of the convincing arguments made by the business community during the public comment phase of the development of the Guidelines,21 the U.S. Sentencing Commission accepted the premise that it would not be fair to impose harsh fines on organizations that had taken all reasonable steps to prevent criminal conduct. The Guidelines set forth minimum criteria for an effective corporate compliance and ethics program ( Program ). Under the Guidelines, an organization convicted of a criminal offense can substantially mitigate its punishment (fines and probation) if it can show that it has an effective Program.22 The Guidelinescriteria also are used by regulators and prosecutors in civil, as well as criminal, matters to assess the effectiveness of companies Programs and what type of enforcement action, if any, should be brought against a company. 23 FERC now has joined the ranks of agencies drawing on the Guidelines in
In his statement accompanying the release of the Enforcement Policy Statement, C h a i r m a n K e l l i h e r s a i d : We h a v e a d u t y t o b e c l e a r o n w h a t t h e r u l e s a r e . C o m p l i a n c e s h o u l d n o t b e elusive, it should not be subjective, and it should be objective to the greatest extent possible. Our goal is to encourage compliance and to quickly identify and sanction non-c o m p l i a n c e . C h a i r m a n Joseph T. Kelliher, Statement at the October 20, 2005 FERC Public Meeting, available at http://www.ferc.gov/whats-new/hd-current/10-20-05-kelliher-M-1.asp.
19 20 18
See generally U n i t e dS t a t e s S e n t e n c i n gC o m m n , Supplementary Report on Sentencing Guidelines for Organizations (Aug. 30, 1991), http://www.ussc.gov/orgguide.htm. See Ilene H. Nagel & Winthrop M. Swenson, The Federal Sentencing Guidelines for Corporations: Their Development, Theoretical Underpinnings, and Some Thoughts about Their Future, 71 WASH. U. L.Q. 205, 236-37 & n.161 (1993) (discussing the influence of corporate counsel t e s t i m o n yo n t h e C o m m i s s i o n s c h o i c e b e t w e e n o p t i m a l p u n i s h m e n t a n d c a r r o t -and-s t i c k m o d e l s for corporate punishment). The Supreme Court recently held that the Sixth Amendment right to a jury trial requires that the current federal sentencing guidelines be advisory, not mandatory. See United States v. Booker, 125 S.Ct. 738 (2005). However, the ruling is not expected to diminish the impact of the G u i d e l i n e s c r i t e r i a a s a b e n c h m a r k f o r t h e design and implementation of effective Programs and their u s e b y r e g u l a t o r s , p r o s e c u t o r s a n d j u d g e s t o a s s e s s t h e e f f e c t i v e n e s s o f a c o m p a n y s P r o g r a m . For example, the Office of the Inspector General for the Department of Health and Human Services has issued compliance guidelines for nursing homes, hospices, emergency rooms a n dh o s p i t a l sw h i c hi s b a s e do nt h es e v e ns t e p so ft h eF e d e r a l S e n t e n c i n gG u i d e l i n e s . See Compliance Program Guidance for Nursing Facilities, 65 Fed. Reg. 14,289, 14,291 (Mar. 16, 2000). The SEC has undertaken to consider the existence of compliance efforts in determining whether and how to charge a company being investigated for violations of securities laws and regulations. See, e.g., SEC Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Exchange Act Release No. 34-44969 (Oct. 23, 2001), http://www.sec.gov/litigation/investreport/3423 22 21
establishing its enforcement policy. In the Enforcement Policy Statement, FERC identified an established, formal independent compliance program as the first factor in determining whether a company has a commitment to compliance sufficient to garner credit in the form of reduced penalties. 24 III. CRITERIA FOR AN EFFECTIVE PROGRAM
In his statement introducing FERC s new enforcement policy, Chairman Kelliher said: Our hope is the Enforcement Policy Statement will encourage regulated entities to 25 establish and maintain effective compliance programs. He added that FERC wants to 26 encourage regulated entities to develop a compliance culture. The Guidelines state that [t]o have an effective compliance and ethics program, . . . an organization shall (1) exercise due diligence to prevent and detect criminal conduct; and (2) otherwise promote an organizational culture that encourages ethical conduct and a commitment to compliance with 27 the law. To meet the above criteria, the Guidelines provide that a company s Program must, at a minimum, include the components discussed in subsections A through K below. A. PERIODIC RISK ASSESSMENTS Compliance is by its nature a dynamic process that requires adjustments to changed circumstances. Among the factors FERC will consider in assessing the effectiveness of a Program is how often the Program is reviewed and modified.28 Similarly, section 8B2.1(c) of the Guidelines requires that a company periodically assess the risk of unlawful conduct. Upon identification of risk areas, a company must modify its Program, as necessary, to reduce the risk of unlawful conduct in those areas.29 To identify its major risk areas, a company should ask: What has gone wrong at the company in the past?
44969.htm. In 2003, DOJ issued a memorandum directing all U.S. attorneys to consider the e f f e c t i v e n e s s o f a c o m p a n y s c o m p l i a n c e p r o g r a mw h e nw e i g h i n gw h e t h e r t o b r i n gc r i m i n a l c h a r g e s against it. See Memorandum from Deputy Attorney General Larry D. Thompson to Heads of D e p a r t m e n t C o m p o n e n t s a n d U n i t e d S t a t e s A t t o r n e y s , P r i n c i p l e s o f F e d e r a l P r o s e c u t i o n o f B u s i n e s s O r g a n i z a t i o n s ( J a n . 2 0 , 2 0 0 3 ) .F E R Cc i t e d b o t h t h e S E Cr e p o r t a n d t h e D O J m e m o r a n d u m , e a c h o f which explicitly relies on the Guidelines, as sources of its Enforcement Policy Statement. Enforcement Policy Statement at PP 7, 9-10.
24 25
Id. at P 22.
Chairman Joseph T. Kelliher, Statement at the October 20, 2005 FERC Public Meeting, http://www.ferc.gov/whats-new/hd-current/10-20-05-kelliher-M-1.asp.
26 27 28 29
Id. USSG 8B2.1(a). Enforcement Policy Statement at P 22. See USSG 8B2.1(c).
ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK What near misses have occurred at the company in the past? What compliance failures have occurred at peer companies? What could happen in the future?
Sources of information that a company typically can utilize to help answer these questions include: Internal documentation relating to: o litigation o dealings with governments o customer complaints o employee complaints/concerns o audit reports o disclosure documents o contracts External documentation relating to: o orders or settlements of regulators in compliance proceedings o trade association information o public filings of peer companies o news stories Interviews of: o employees in support departments like legal, human resources, audit and finance o employees from each business line o outside lawyers and consultants with industry experience Companies should prioritize their risk assessment findings by evaluating (i) the nature and seriousness of potential unlawful conduct, (ii) the likelihood that certain unlawful conduct may occur because of the nature of the company s business, and, as noted above,
(iii) the company s prior history.30 The Guidelines commentary states that [i]f, because of the nature of an organization s business, there is a substantial risk that certain types of [unlawful] conduct may occur, the organization shall take reasonable steps to prevent and detect that type of [unlawful] conduct. For example, an organization that, due to the nature of its business, employs sales personnel who have flexibility to set prices shall establish 31 standards and procedures designed to prevent and detect price-fixing. By prioritizing its findings, a company will be able first to address its greatest risks. A company can most effectively manage its risks if it understands their root causes. At one end of the employee misconduct spectrum is misconduct that stems from ignorance or misunderstanding of legal or regulatory requirements or company policy. At the other end is purposeful bad conduct. Failure to understand legal requirements suggests a need for better written policies and procedures and/or improved communication of them (e.g., training), while purposeful bad conduct suggests a possible need for better monitoring, auditing, more consistent disciplinary action, changing employee incentives, and/or reevaluating the corporate culture and tone being communicated by senior management. B. STANDARDS AND PROCEDURES TO PREVENT AND DETECT UNLAWFUL CONDUCT A central factor considered by FERC when determining whether to give credit under its Enforcement Policy Statement is whether the company has an established, formal, independent compliance program.32 Similarly, section 8B2.1(b)(1) of the Guidelines requires that a company establish standards and procedures to prevent and detect criminal 33 conduct, though a Program should also endeavor to foster ethical conduct and compliance with all laws, not just criminal laws. As noted above, a company s risk assessment can help identify those subject areas as to which compliance policies and procedures should be developed or modified so that employees can fully understand the company s expectations for their conduct. The other chapters in this Handbook are devoted to discussion of specific FERC and related compliance requirements that need to be factored into effective compliance programs for electric companies. C. DIRECTORS PROGRAM OVERSIGHT RESPONSIBILITIES Effective compliance starts at the top. Key among the factors considered by FERC in determining a company s commitment to compliance is whether a compliance program is supervised by an officer or other high-ranking official, and whether the company s designated compliance official reports to or has independent access to the chief executive officer and/or the board of directors.34 Section 8B2.1(b)(2)(A) of the Guidelines likewise requires that a company s board of directors exercise reasonable oversight with respect to the
30 31 32 33 34
USSG 8B2.1, cmt. n.6. Id. 8B2.1, cmt. n.6(A)(ii). Enforcement Policy Statement at P 22. USSG 8B2.1(b)(1). Enforcement Policy Statement at P 22.
10
Program s implementation and effectiveness. Set forth below are what we view as some of directorsprincipal tasks with respect to overseeing a company s Program. Certain suggestions for addressing these responsibilities are also set forth below. One: K now the primary features of the Program Directors should be knowledgeable about the content and operation of the company s Program.35 Although directors need not know every detail of the Program, they should be familiar with its primary features and how they work together to create an effective Program. The company officer with responsibility for the Program s day-to-day operations can present directors with an information session about the primary features of the Program and any necessary or suggested modifications or improvements to the Program. Two: K now the company s major compliance risks and typical compliance problems Directors should be knowledgeable about the company s and industry s specific compliance risks and should be kept apprised of the typical compliance problems the company and industry face. This can be done by: establishing procedures for apprising the board of significant regulatory and industry developments affecting the company s risk; overseeing, and receiving reports on, the risk assessments conducted by the company and the types of compliance issues that have been reported through the helpline or other reporting lines; confirming that the Program components adequately address the risks identified in any risk assessment; and verifying that any material ethics or compliance issue identified has been or is being adequately addressed and that steps have been or are being taken to prevent the problem from recurring, including making modifications to the Program where appropriate. Three: Demonstrate a strong tone at the top A critical component of any effective Program is a strong tone at the top. A company can have a detailed and elaborate Program on paper; but if employees do not think management and the directors support the Program, then it likely will be viewed as ineffective. Indeed, FERC has highlighted this element of compliance, noting that whether compliance is fully supported by senior managementis a factor to be considered in
35
See USSG 8B2.1(b)(2)(A).
11
determining a company s commitment to compliance. 36 Directors can demonstrate their commitment to the Program by: devoting adequate meeting time to its consideration; making clear to management its responsibility to report to the board any red flags or other signs of improper conduct or questionable risk; overseeing management s involvement in and commitment to the Program; scrupulously adhering to the code of conduct and other company policies applicable to directors; and considering an employee s compliance with FERC regulations and the reporting of any violations in that employee s compensation, promotion and disciplinary 37 action. Four: Document, document, document All board actions in connection with its Program oversight responsibilities should be documented to facilitate the company s ability to demonstrate the board s involvement to an 38 auditor or investigator. Board and committee minutes should highlight when the board or audit or other committee has addressed Program-related matters. Reports presented to the board regarding the Program should, as appropriate, and subject to confidentiality and privilege considerations, be retained with the board minutes. Training programs or information sessions attended by directors also should be documented as appropriate.39 D. SENIOR OFFICER(S) PROGRAM RESPONSIBILITY As discussed in Chapter 10, FERC first stressed the importance of high-level accountability by requiring the appointment of a Chief Compliance Officer responsible for Standards of Conduct compliance,40 although FERC does not specifically require that this individual be part of senior management. In its recent Enforcement Policy Statement, however, FERC broadened its focus to compliance with all matters subject to its jurisdiction under Part II of the FPA, and stated that it will consider whether a compliance program is supervised by an officer or high-ranking official when measuring a company s
36 37 38
Enforcement Policy Statement at P 22. Id. For a discussion of compliance issues related to records retention, see Chapter 20 of this
Handbook. Section 8B2.1(b)(4) of the Guidelines states that directors should be trained by the c o m p a n yo n s u b j e c t s t h a t a r e a p p r o p r i a t e t o t h e d i r e c t o r s r o l e s a n d r e s p o n s i b i l i t i e s f o r t h e c o m p a n y . This requirement is discussed in greater detail below.
40 39
See 18 C.F.R. 358.4(e)(6) (2005).
12
commitment to compliance. 41 The Guidelines impose a similar but more specific requirement. Section 8B2.1(b)(2)(B) of the Guidelines requires that senior management ensure that the company has an effective Program and that one or more specific individual(s) within senior management has been assigned overall Program responsibility. Such individual(s) should have regular interaction with the person assigned day-to-day responsibility of the Program and should keep other members of the senior management team apprised of the status of the Program and any significant updates. It is advisable to delegate such responsibility in a formal fashion (e.g., by board resolution or job description). Senior officers should (i) be knowledgeable about the content and operation of the Program, (ii) conduct their responsibilities in a manner consistent with a Company s policies and procedures, and (iii) promote a company culture that encourages ethical conduct and a commitment to compliance with the law.42 Senior officers, like the board of directors, should lead by example by setting the proper tone at the top. Senior officers can help set the proper tone by: devoting adequate meeting time to consideration of compliance; scrupulously adhering to company policies and procedures; communicating to employees the importance of adhering to company policies and procedures; consistently promoting the Program through appropriate incentives;43 and consistently enforcing the Program through appropriate disciplinary measures.44 E. SPECIFIC INDIVIDUAL DELEGATED DAY-TO-DAY OPERATIONAL RESPONSIBILITY The Enforcement Policy Statement indicates that a specific person should be designated as a compliance official, and that such official should have independent access to the chief executive officer and/or the board of directors.45 Likewise, section 8B2.1(b)(2)(C) of the Guidelines requires that a specific individual within the organization be delegated day-to-day operational responsibility for the Program. That individual should: report periodically to senior management;
Enforcement Policy Statement at P 22. It is worth noting that many of the elements of an effective compliance program developed in the Enforcement Policy Statement already are required with respect to Standards of Conduct compliance. Thus, companies looking internally for expertise to develop a broader program may wish to start with personnel charged with Standards of Conduct compliance.
42 43 44 45 41
USSG 8B2.1 cmt. n.3. Id. 8B2.1(b)(6). Id. For further discussion on this point, see infra Part III.J. Enforcement Policy Statement at P 22.
HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM report, at least annually, to the board of directors or a board committee; be given adequate resources;46 be given appropriate authority; and be given direct access to the board of directors or a board committee.
13
The purpose of the above requirements is to ensure that the Program is given sufficient support and stature. This, in turn, will be a strong indicator of the company s commitment to the success and integrity of its Program. To further demonstrate the Program s importance, it is advisable to delegate and describe the functions of the individual with operational responsibility for the Program by board resolution, job description or charter. F. BACKGROUND CHECKS AT HIRE AND PROMOTION The Guidelines call for background checks on prospective employees with substantial discretion, including potentially traders as well as management-level employees. Section 8B2.1(b)(3) of the Guidelines requires a company to use reasonable efforts not to include within the substantial authority personnel of a company any individual whom the company knew or should have known through the exercise of due diligence, has engaged in illegal 47 activities or other conduct inconsistent with the company s policies and procedures. Commentary to the Guidelines provides that this requirement applies at the time of both hire and promotion.48 This Guidelinescriterion was not specifically replicated in FERC s Enforcement Policy Statement, but might nonetheless be something that FERC would
Under the Enforcement Policy Statement, FERC too will examine the sufficiency of resources dedicated to a compliance program in evaluating its effectiveness. Id. U S S G 8 B 2 . 1 ( b ) ( 3 ) .T h e c o m m e n t a r y t o a n e a r l i e r s e c t i o n d e f i n e s t h e t e r m s u b s t a n t i a l authori t y p e r s o n n e l a s f o l l o w s :
47
46
S u b s t a n t i a l a u t h o r i t yp e r s o n n e l m e a n si n d i v i d u a l sw h ow i t h i nt h es c o p eo f t h e i r authority exercise a substantial measure of discretion in acting on behalf of an organization. The term includes high-level personnel of the organization, individuals who exercise substantial supervisory authority (e.g., a plant manager, a sales m a n a g e r ) , a n da n yo t h e r i n d i v i d u a l sw h o , a l t h o u g hn o t ap a r t o f a no r g a n i z a t i o n s management, nevertheless exercise substantial discretion when acting within the scope of their authority (e.g., an individual with authority in an organization to negotiate or set price levels or an individual authorized to negotiate or approve significant contracts). Whether an individual falls within this category must be determined on a case-by-case basis. USSG 8A1.2 cmt. n.3(c).
48
USSG 8B2.1 cmt. 4(B).
14
c o n s i d e r w o r t h y o f c r e d i t in appropriate circumstances e.g., if a company had performed 49 a background che c k o n a t r a d e r w h o l a t e r w e n t r o g u e . The components of a background check can vary but should be sufficient to address the above due diligence standard and should correlate with the responsibilities the individual is anticipated to be assigned. For example, a general background check may entail the following checks: (1) education, (2) driver s license, (3) criminal history and (4) employment history for last five years. Companies hiring or promoting a trader with significant discretion may also wish to consider electronic research in databases of FERC precedent and trade press to see if the trader s name has arisen in connection with conduct that, while not criminal, was deemed unlawful. A background check for an employee who will be assigned accounting/financial responsibilities may also include the following additional checks: (1) credit history, (2) Wall Street (call to the SEC), and (3) FBI. A background check at the time of promotion may include the same background check conducted at hire, unless the time of promotion is within close proximity to the time of hire. Moreover, additional checks which correspond to the increased responsibility being delegated at promotion should also be conducted. A background check at the time of promotion should also include a review of an employee s personnel file to ensure that the individual s conduct does not demonstrate any activity inconsistent with an effective Program. For example, an employee who may have consistently achieved financial goals but is also systematically abusive of FERC requirements likely would not be the best person to promote for some positions. C o m m e n t a r yt ot h eG u i d e l i n e sa l s op r o v i d e s [ w ] i t hr e s p e c tt ot h eh i r i n g and promotion of such individuals, an organization shall consider the relatedness of the individual s illegal activities and other misconduct (i.e., other conduct inconsistent with an effective compliance and ethics program) to the specific responsibilities the individual is anticipated to be assigned and other factors such as: (i) the recency of the individual s illegal activities and other misconduct; and (ii) whether the individual has engaged in other such 50 i l l e g a l a c t i v i t i e s a n d o t h e r s u c h m i s c o n d u c t . C o n s e q u e n t l y , w h i l eab a c k g r o u n dc h e c km a yr e s u l t i na h i t of some kind, this should not automatically eliminate a candidate for employment. The company also should consider how such illegal activity or misconduct relates to the candidate s anticipated responsibilities, the recency of such illegal activity or misconduct and if the candidate has been found to have additional illegal activity or misconduct that would lead a reasonable person to believe that the candidate has the propensity to violate the law. For example, a 35 y e a r o l d c a n d i d a t e w h o h a s a c r i m i n a l r e c o r d a s a r e s u l t o f a c o l l e g e p r a n k c o n d u c t e d a t t h e a g e o f 1 9a n dw h oh a s n oo t h e r b l e m i s ho nh i s c r i m i n a l r e c o r da n dn oo t h e r h i t r e s u l t i n g from a full background check, could reasonably be considered for a position at a company.
In its Enforcement Policy Statement, F E R Cs a i dt h a t b e c a u s e n ol i s t c a nc o v e r e v e r y possible significant factor, [FERC] will consider other pertinent factors as appr o p r i a t e . Enforcement Policy Statement at P 17.
49 50
USSG 8B2.1 cmt. n.4(B) (emphasis added).
HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM G. COMMUNICATION OF STANDARDS AND PROCEDURES
15
A Program will not be effective if it is not understood by employees. FERC indicated in its Enforcement Policy Statement that the frequency and quality of training will be considered in evaluating a company s commitment to compliance. FERC reflected that a t r a i n i n gp r o g r a ms h o u l db e s u f f i c i e n t l y d e t a i l e da n dt h o r o u g h t oi n s t i l l a n u n d e r s t a n d i n go f 51 t h e r e l e v a n t r u l e s a n d t h e i m p o r t a n c e o f c o m p l i a n c e . Though FERC indicated that training s h o u l db e p r o v i d e d t o r e l e v a n t p e r s o n n e l w i t h o u t f u r t h e r d e f i n i n g s u c h p e r s o n n e l , i t m a k e s sense to be cautious and overbroad in determining which personnel are relevant, rather than risk an unmitigated penalty because a wrongdoer was not appropriately trained. Similarly, se c t i o n 8 B 2 . 1 ( b ) ( 4 ) o f t h e G u i d e l i n e s p r o v i d e s t h a t a c o m p a n y m u s t t a k e r e a s o n a b l e s t e p s t o communicate periodically and in a practical manner its standards and procedures, and other aspects of its compliance and ethics program, . . . by conducting effective training programs and otherwise disseminating information appropriate to such individual s respective roles and r e s p o n s i b i l i t i e s . T h i s t r a i n i n gr e q u i r e m e n t a p p l i e s n o t o n l yt oe m p l o y e e s a n do f f i c e r s , b u t also to directors and, as appropriate, agents. A company s risk assessment, as discussed above, will often highlight the substantive areas and individuals or functions for which training programs are advisable. All employees should attend certain training programs, e.g., ethics and compliance program, rollout or overview, sexual harassment. Only certain groups of employees need attend other training programs, such as those covering many of the topics addressed in this Handbook. Training programs can be delivered in different formats, such as computer-based or classroom training. Companies can develop training programs in-house or can utilize the resources of external consultants who specialize in developing and implementing training programs. For example, we developed a computer-based training program on FERC s Standards of Conduct for the Edison Electric Institute that is being used by many electric utilities and gas pipelines. The Guidelines provide that training programs should be conducted periodically and effectively. A company can, among other things, utilize the findings of its risk assessments to determine how frequently certain training programs should be conducted.52 To help determine whether a training program has been effective, there are various methods available, such as (1) reviewing records of post-training misconduct, (2) surveys of employee opinions, (3) tests to assess employees understanding after the training, (4) evaluations of the training program completed by employees who attended such program, and (5) focus groups to assess employee opinions. Companies should make attendance at all applicable Program training programs mandatory and should also have mechanisms in place to track employee attendance.
Enforcement Policy Statement at P 22. Also, as discussed in Chapter 10, FERC requires transmission providers to conduct training on the Standards of Conduct. FERC expects annual retraining under the Standards of Conduct, and training of new employees, as appropriate, upon hire.
52
51
16
Section 8B2.1(b)(4) of the Guidelines also provides that a company should communicate its standards and procedures in ways other than training programs. 53 This is to encourage companies to remind employees frequently of the importance of the Program and of complying with the company s standards and procedures. Other forms of communication can include (1) newsletters, (2) electronic bulletin boards, (3) email, (4) memoranda or publications and (5) letters to employees. As discussed in Chapter 10, FERC requires companies to provide copies of procedures for implementing the Standards of Conduct to employees. Senior officers also should find opportunities to communicate personally to their employees the importance of conducting business ethically and in compliance with the company s Program. H. AUDITING AND MONITORING, INCLUDING INTERNAL REPORTING MECHANISMS In its recent Enforcement Policy Statement, FERC stressed the need for an ongoing process for companies to audit their compliance with FERC s regulations. 54 Similarly, section 8B2.1(b)(5)(A) of the Guidelines provides that a company should take reasonable steps, such as auditing and monitoring, to ensure that its Program is followed. Auditing r e f e r s t o a n y s y s t e m a t i c a t t e m p t t or e v i e wa n d v e r i f y t h a t t h e r e h a s i nf a c t b e e n c o m p l i a n c e with the corporation s p u b l i s h e ds t a n d a r d s a n d t e n d s t oh a v e a r e t r o s p e c t i v e o r b a c k w a r d 55 l o o k i n gc o n n o t a t i o n . I nc o n t r a s t ,m o n i t o r i n g t e n d st om e a n ac o n t e m p o r a n e o u s 56 i n s p e c t i o n o f a n a c t i v i t y t h a t i s u n d e r r e v i e w . The methods used to audit a Program often depend on the size of a company. Larger public companies tend to have well-staffed internal audit departments which can conduct periodic audits of a company s Program. Smaller companies or, in the case of some specialized topics, even larger companies may have to depend on others to help conduct a Program audit, such as in-house counsel or an outside consultant. Whoever conducts an audit should (1) be independent of line management in order to have credibility with a prosecutor and with the employees who are a source of information, (2) have access to required information or personnel, (3) be of sufficient rank to command access without obstruction, and (4) have access to senior management, and where appropriate, the audit committee of the board of directors.57 An example of monitoring is the tracking of attendance at training programs to ensure compliance with employee training requirements. Another would be establishment of a
See U S S G8 B 2 . 1 ( b ) ( 4 ) ( r e q u i r i n g c o m p a n i e s t o t a k e r e a s o n a b l e s t e p s f o r o t h e r w i s e disseminating information appropriate to s u c h i n d i v i d u a l s r e s p e c t i v e r o l e s a n d r e s p o n s i b i l i t i e s ) .

53 54 55
BUREAU OF NAT L AFFAIRS, AMERICAN CORP. COUNSEL ASS N, BNA/ACCA COMPLIANCE MANUAL, PREVENTION OF CORPORATE LIABILITY, Ch. 4 D at 4:29 (No. 37 1999 & Supp. No. 61 2003).
56 57
Id. Id.
17
program to screen new energy products for compliance with FERC s Market Behavior Rules (see Chapter 9) or with CFTC requirements (see Chapter 18). Internal reporting systems are another monitoring mechanism. The Enforcement Policy Statement highlights FERC s interest in discerning how a violation came to light and 58 whether the company act[ed] immediately when i tl e a r n e do ft h em i s c o n d u c t . Accordingly, FERC stressed that senior management should encourage employees to provide information to identify misconduct. Section 8B2.1(5)(C) of the Guidelines provides that a company s h o u l d h a v e a n d p u b l i c i z e a s y s t e m , w h i c h m a y i n c l u d e m e c h a n i s m s t h a t a l l o wf o r anonymity or confidentiality, whereby the organization s employees and agents may report or seek guidance regarding potential and actual criminal conduct without fear of reta l i a t i o n . There are several types of internal reporting mechanisms available. These include (1) h e l p l i n e s ( e i t h e r i n t e r n a l l yo r e x t e r n a l l ya d m i n i s t e r e d ) , ( 2 ) o m b u d s p e r s o n , ( 3 ) o p e nd o o r policy and (4) compliance officer s or general counsel s telephone number. Whatever mechanisms a company has made available to report or seek guidance should be adequately publicized. A helpline can facilitate anonymous reporting by employees. Although neither FERC nor the Guidelines require anonymous reporting,59 a helpline or other mechanism that allows anonymous reports can encourage employees to report or seek guidance. A company should maintain records of the complaints lodged so that the company may, over time, identify any trends that would indicate a need for modifications within the Program. Records should also be maintained regarding how each call was addressed. A company will thereby be able to demonstrate that it responds appropriately to issues brought to its attention. Although a company should endeavor to maintain the confidentiality of individual reports, it cannot guarantee their absolute confidentiality because confidentiality may be limited by the company s legal obligations, such as those relating to self-disclosure, subpoenas and civil discovery requests, as well as to the needs of a particular investigation. To encourage reporting, company policy should provide that no employee will be subject to retaliation because of a good faith report of a complaint or concern.60 This
58 59
In contrast to the Guidelines, section 301 of the Sarbanes-Oxley Act of 2002 requires audit committees of public companies to establish procedures for employees to report anonymously concerns regarding questionable accounting or auditing matters. See 15 U.S.C. 78j-1(m)(4)(B) ( 2 0 0 4 ) ( r e q u i r i n ga u d i t c o m m i t t e e st o e s t a b l i s hp r o c e d u r e sf o r . . . t h ec o n f i d e n t i a l , a n o n y m o u s submission by employees . . . of concerns regarding questio n a b l ea c c o u n t i n go r a u d i t i n gm a t t e r s ) . Certain other regulatory requirements for reporting procedures do not require that they be anonymous. For example, (i) Item 7(h) of Schedule 14A of the Securities Exchange Act of 1934, as amended, requires procedures for communication between shareholders and directors of public companies; and (ii) New York Stock Exchange Rule 303A.03 requires procedures for communication between interested parties and the director who presides at executive sessions of non-management directors or with the non-management directors as a group of listed companies.
60
See USSG 8B2.1(b)(5)(C).
18
message should be highlighted in any policy or procedure that discusses the mechanisms available for reporting violations or seeking guidance. A company should implement reporting systems that are best suited to its culture and conform to applicable law. Companies also should consider evidentiary matters in evaluating a reporting mechanism. If employees are asked to report violations by email, for example, an employee may erroneously declare in an email that could potentially have wide circulation that a violation has occurred. If, in fact, no violation occurred, that email could serve as a distraction in any subsequent FERC audit or litigation. I. PERIODIC EVALUATION OF THE PROGRAM Electric companies operate in a dynamic environment. Both internal and external changes can impair the effectiveness of a Program unless the Program is itself dynamically responsive to change. For this reason, FERC has indicated that the frequency of a company s review and modification of its compliance program is a factor to be considered in evaluating its commitment to compliance.61 Similarly, section 8B2.1(b)(5)(B) of the Guidelines p r o v i d e s t h a t c o m p a n i e s m u s t e v a l u a t e p e r i o d i c a l l y t h e e f f e c t i v e n e s s o f t h e i r P r o g r a m s t o assess if the systems in place are achieving the Program s goals.62 This evaluation may be conducted by company personnel or outside compliance program experts. For example, in recent years, we have assisted over 250 companies in evaluating their respective Programs. A Program assessment should include a gap analysis that compares the Program s components to the legal and regulatory requirements that the Program was designed to address, using the Guidelines as a framework for that comparison. If gaps are identified, an action plan for needed or suggested Program modifications or additions should be developed and implemented. How frequently a company evaluates components of or its entire Program should be guided by the level of legal risk the company s operations present, the results of prior assessments and claims against the company, among other factors. A company may wish to conduct more focused and frequent reviews of those aspects of its Program that address particular high risk areas and/or complex regulations. J. PROMOTE AND ENFORCE THE PROGRAM CONSISTENTLY In the early days of competition, it was not uncommon for power traders bonuses to be tied largely or even exclusively to financial performance. Typically there was no company-specified incentive or disincentive related to compliance rules. But, properly structured, such incentives and disincentives can be used to balance priorities and maintain employee activity within regulatory parameters. For this reason, FERC encourages companies to adopt policies regarding compensation and promotion that take into account the employee s compliance with FERC regulations. FERC also notes that disciplinary action against employees involved in violations is an indication of a company s commitment to
61 62
Enforcement Policy Statement at P 22. USSG 8B2.1(b)(5)(B).
19
compliance.63 Similarly, section 8B2.1(b)(6) of the Guidelines provides that a company s P r o g r a ms h o u l d b e p r o m o t e d a n d e n f o r c e d c o n s i s t e n t l y t h r o u g h o u t t h e o r g a n i z a t i o n t h r o u g h (A) appropriate incentives to perform in accordance with the compliance and ethics program; and (B) appropriate disciplinary measures for engaging in criminal conduct and for failing to 64 t a k e r e a s o n a b l e s t e p s t o p r e v e n t o r d e t e c t c r i m i n a l c o n d u c t . Among the incentives that could be used to promote compliance with the Program are (1) performance evaluations, (2) sector, group or division goals or (3) site business goals. Including performance in accordance with the Program as a component of a performance evaluation or team goal will underscore the importance of compliance and the Program in a positive way. Disciplinary measures for violations of law and company policy must be appropriate for the particular situation and consistently applied. As stated in Application Note 5 to se c t i o n8 B 2 . 1o f t h eG u i d e l i n e s [ a ] d e q u a t ed i s c i p l i n eo fi n d i v i d u a l sr e s p o n s i b l ef o ra n offense is a necessary component of enforcement; however, the form of discipline that will 65 b e a p p r o p r i a t e w i l l b e c a s e s p e c i f i c . Companies should keep records of the investigations conducted and any resulting disciplinary action. However, they should not blindly follow the discipline administered in the past. Rather, all the facts and circumstances of each situation should be considered and the appropriate discipline that would be consistent with past practice should be administered. K. RESPOND APPROPRIATELY TO VIOLATIONS TO PREVENT FUTURE OCCURRENCES Given the proliferation of behavioral rules applicable to utility employees, it is perhaps inevitable that compliance problems will occur. Taking corrective action could help to limit any exposure going forward. For example, FERC penalties can accrue on a daily basis.66 Taking immediate steps to stop any misconduct has been deemed important by FERC in its new Enforcement Policy Statement.67 Prompt and full self-reporting of violations, coupled with steps to correct the adverse impact on customers or third parties from the misconduct, may result in a reduction in the level of penalties.68 The Guidelines also call for corrective action. Section 8B2.1(b)(7) of the Guidelines provides that once a company has become aware of criminal conduct, it must take reasonable steps, including
63 64 65 66
Enforcement Policy Statement at P 22. USSG 8B2.1(b)(6). USSG 8B2.1 cmt. n.5.
See 16 U.S.C. 825o-1 (permitting FERC to impose penalties of up to $1,000,000 per day for violations of Part II of the FPA).
67 68
Id. at P 25. Of course, self-reporting also carries with it the risk that FERC will penalize a company for conduct that might not otherwise have been detected.
20
making necessary modifications to its Program, to prevent further similar misconduct.69 Consequently, after an investigation is completed, the company should endeavor to understand why and how the conduct occurred. Answers to such questions will help the company determine if any modifications to the Program or any other business practice are required. CONCLUSION The Enforcement Policy Statement creates a strong incentive for companies to adopt a broad-based FERC compliance Program, and many companies will be looking for the right model for such a Program. While the Enforcement Policy Statement itself is short on details, the parallel Guidelines criteria for an effective program and other regulators , prosecutors and companies application of them provide detailed guidance for the design and implementation of an effective FERC Program. Moreover, many electric companies have some experience developing programs for compliance with other areas of regulation pursuant to the Guidelines, and so have internal resources to draw upon in forming such a Program, in addition to external resources such as Skadden, Arps.
See USSG 8B2.1(b)(7). While this section of the Guidelines requires that steps be taken to prevent future criminal misconduct, a Program should also endeavor to foster ethical conduct and compliance with all laws.
69
Chapter 2 FERC Audits and Investigations

GERALD RICHMAN The Federal Energy Regulatory C o m m i s s i o n ( F E R C ) r e g u l a r l y and increasingly conducts audits and investigations of traditional electric utilities and power marketers to 1 determine their compliance with the F e d e r a l P o w e r A c t ( F P A ) and with t h ea g e n c y s orders and regulations that implement the statute. This type of FERC activity has become m o r e v i s i b l e , a n d a t t i m e s m o r e a g g r e s s i v e , i n a p o s t -E n r o n w o r l d . Mo r e o v e r , F E R C s c i v i l p e n a l t y a u t h o r i t y u n d e r t he FPA was greatly expanded by the 2 E n e r g y P o l i c yA c t o f 2 0 0 5( E P A c t 2 0 0 5 ) . P r e v i o u s l y , F E R C s a u t h o r i t y t oi m p o s e c i v i l penalties outside of the area of compliance with FERC-issued hydroelectric licenses and permits was limited to violations of the FPA provisions dealing with mandated wheeling and interconnections, requests for wholesale transmission service, and EWG sales. EPAct 2005 a m e n d e dt h eF P A s c i v i l p e n a l t yp r o v i s i o n st oc o v e r a l l v i o l a t i o n so f P a r t I I o f t h eF P A (dealing with wholesale electric sales and transmission service) and expanded the potential penalty from not more than $10,000 for each day of violation to not more than $1 million for each day of violation.3 Thus, the potential stakes involved in FERC audits and investigations have been dramatically increased. With these concerns in mind, this chapter will first provide the practitioner with a general understanding of the audit and investigative practices of FERC. Second, this chapter will discuss considerations that are relevant in responding to FERC Staff once an audit or investigation is underway. I. FERC AUDIT AND INVESTIGATION PROCESS
FERC has statutory authority to conduct audits and investigations. This authority is found in the following sections of the FPA: section 301, requiring utilities to maintain accounts and records;4 section 307, authorizing FERC investigations necessary or appropriate
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 2000, Mr. Richman served as an attorney in the Enforcement Section of the Office of the General Counsel at the Federal Energy Regulatory Commission. At Skadden, Mr. Richman has regularly assisted energy companies responding to FERC audits and investigations.
1 2 3
16 U.S.C. 791a to 825r (2005). Pub. L. No. 109-58, 119 Stat. 594 (2005).
See EPAct 2005 1284(e), 119 Stat. at 980 (amending 16 U.S.C. 825o-l). For a d e t a i l e d d i s c u s s i o n o f F E R C s a u thority to impose civil penalties under the FPA, see Chapter 3 of this Handbook. 16 U.S.C. 825(a). In addition, section 1264 of the Public Utility Holding Company Act of 2005, enacted by EPAct 2005, mandates FERC access to certain records of holding companies,
4
22
to determine the existence of violations of the FPA or underlying FERC rules, regulations or orders;5 and section 311, authorizing investigations necessary and appropriate to enable FERC to make recommendations to Congress concerning legislation.6 Moreover, courts h a v ev i e w e dt h i sa u t h o r i t yb r o a d l y , s ot h a tw h i l et h e r ea r el i m i t so nF E R C su l t i m a t e r e m e d i a l a u t h o r i t y , t h e a g e n c y s a b i l i t y to inquire and compel data production appears almost u n l i m i t e d : [ W] h i l et h er e g u l a t o r ya n dr a t es e t t i n gj u r i s d i c t i o no ft h eC o m m i s s i o ni s narrowly defined, Congress has given it broad authority to gather data which would in any 7 rational way aid it in the performance of its statutory function. F E R C sp r i n c i p a li n v e s t i g a t i v ea r m i si t sO f f i c eo f Ma r k e tO v e r s i g h ta n d I n v e s t i g a t i o n s ( O MO I ) .T oad e g r e e , O MO I is the successor to the FERC Enforcement Section that existed throughout the 1990s, but OMOI is a significantly expanded unit. The previous Enforcement Section had approximately 15 lawyers and limited other professional staff. However, partially in response to the California Energy Crisis, FERC greatly increased its market monitoring and oversight functions. O MO I s o f f i c i a l m i s s i o ni s t og u i d et h e evolution and operation of energy markets to ensure effective regulation and to protect customers through understanding markets and their regulation, timely identification and remediation of market problem s ,a n da s s u r e dc o m p l i a n c ew i t h[ F E R C s ]r u l e sa n d 8 r e g u l a t i o n s . T ot h i s e n d , O MO I h a s a n i n v e s t i g a t o r yt e a mo f m o r e t h a n7 0a t t o r n e y s , a u d i t o r s , analysts, and engineers [who monitor] the energy marketplace for potential problems and 9 work[] to achieve corporate compliance. I na d d i t i o n , O MO I h a sa n a n a l y t i ct e a mo f another 50 professional staff [who probe] market developments to detect anomalous or
t h e i r a s s o c i a t e c o m p a n i e s , a n d t h e i r a f f i l i a t e s .T h e c o v e r e d r e c o r d s a r e t h o s e t h a t F E R C d e t e r m i n e s are relevant to costs incurred by a public utility . . . that is an associate company of such holding company and necessary or appropriate for the protection of utility customers with respect to j u r i s d i c t i o n a l r a t e s . 4 2 U . S . C . 1 6 4 5 2 .
5 6
16 U.S.C. 825(f).
Id. 825(j). FERC has similar authority under sections 8 and 14 of the Natural Gas Act ( N G A ) .N G As e c t i o n 8 , 1 5 U . S . C . 7 1 7 g , r e q uires natural gas pipelines to maintain accounts and records, while section 14, id. 717m, authorizes FERC investigations necessary or appropriate to determine the existence of violations of the NGA or underlying FERC rules, regulations or orders. Union Oil Co. v. FPC, 542 F.2d 1036, 1039 (9th Cir. 1976) (emphasis added) (construing language in section 14(a) of the Natural Gas Act, 15 U.S.C. 717m(a), that is virtually identical to the language in FPA section 307). Where the relevant provisions of the NGA and the FPA are substantially identical, the established practice of the courts is to cite interchangeably decisions interpreting the pertinent sections of the two statutes. See, e.g., Arkansas La. Gas Co. v. Hall, 453 U.S. 571, 579 n.7 (1981). The F e d e r a l P o w e r C o m m i s s i o n ( F P C ) w a s F E R C s p r e d e c e s s o r a g e n c y . FERC Staff Report, Energy Market Oversight and Enforcement: Accomplishments and Proposal for Enhanced Penalty Authority, at 4 (Mar. 2005).
9 8 7
Id.
FERC AUDITS AND INVESTIGATIONS suspicious activity, such as attempts at market manipulation or 10 communications or improper c o o p e r a t i o n b e t w e e n m a r k e t p a r t i c i p a n t s .
23 inappropriate
The Director of OMOI reports directly to F E R C sChairman. O MO I sc u r r e n t investigatory activities fall into two basic categories: non-public investigations, and what can b et e r m e da s s e m i -p u b l i c a u d i t s .I np r actice, as discussed below, while there are some procedural differences between the two, the practical differences ultimately may not be overly significant. OMOI conducts investigations pursuant to rules and regulations found in Part 1b of 12 t h eC o m m i s s i o n sregulations. 11 T h e s er e g u l a t i o n s , i nt u r n , p r o v i d ef o r f o r m a l and 13 p r e l i m i n a r y investigations. The technical distinction is that formal investigations are instituted by direction of the Commission,14 whereas preliminary investigations may be instituted by OMOI without seeking Commission authorization.15 In practice, however, there is not much distinction. Formal investigations automatically authorize compelled process, such as subpoenas; but generally it is not hard for OMOI to procure subpoenas in preliminary investigations if necessary to ensure compliance with data requests. And OMOI can recommend that the Commission institute public proceedings (such as a show cause order) based on the results of a preliminary investigation. However, where a formal investigation has been instituted, a target company knows (at least in theory) that there was some front-end input from the Commission. This is not always the case with preliminary investigations. Although not mandated by the regulations, OMOI sometimes may share a draft investigatory report with the company, in advance, allowing the company to submit comments. Moreover, at any time, the company may submit documents, statements of facts, or memoranda of law, for the purpose of explaining its position or furnishing evidence.16 Based on what OMOI finds (or believes it has found) and recommends to the Commission, these investigations can produce a variety of outcomes, including formal proceedings instituted against a company by the Commission to determine whether sanctions or penalties should be imposed, a negotiated consent agreement to forestall such actions, or no action at all if OMOI does not believe it has uncovered violations or serious problems. Because investigations are non-p u b l i c , F E R C s g e n e r a l practice is not to disclose the existence of an investigation that does not result in a show cause order, an adjudicative
10 11 12 13 14 15 16
Id. 18 C.F.R. Part 1b (2005). Id. 1b.5. Id. 1b.6. Id. 1b.1(a), 1b.5. Id. 1b.1(b), 1b.6. Id. 1b.18.
24
proceeding, or an order approving a consent agreement.17 When an investigation is concluded without further action, staff will informally advise the company of this fact, but generally does not provide written confirmation that the investigation has been closed. In addition to conducting investigations pursuant to Part 1b of its regulations, FERC also undertakes audits under authority of FPA section 301, which requires electric utilities to maintain books and records for FERC examination. Historically, these audits were financial in nature, to ensure that companies are in compliance with accounting procedures and 18 requirements related to F E R C s U n i f o r mS y s t e mo f A c c o u n t s . However, in recent years O MO I a n dF E R Ch a v e e x p a n d e da u d i t s i n t ow h a t O MO I d e e m s t ob e o p e r a t i o n a l a r e a s ; 19 for example, implementation of the Open A c c e s sT r a n s m i s s i o nT a r i f f ( O A T T ) ; Open Access Same-Time InformationS y s t e m( OASIS ) administration; methods for processing requests for transmission service; compliance with the Standards of Conduct governing relations between Transmission Providers and their Energy Affiliates;20 compliance with the Codes of Conduct governing relations between the wholesale merchant functions of traditional franchised utilities and their marketing affiliates.21 FERC also has proposed that it begin to conduct reliability audits.22 There does not appear to be a hard and fast rule determining whether OMOI proceeds by investigations or by audits. The subject matter of operational audits over the past several years appears to cover the same areas as OMOI investigations. For example, recent investigations have resulted in FERC-approved consent agreements with specific companies (often involving monetary penalties and/or refunds) arising from allegations relating to OATT administration, the Standards of Conduct, and the Codes of Conduct.23
But see 18 C.F.R. 1b.9 (permitting the Commission to authorize disclosure); see also infra note 43. F E R C s U n i f o r mS y s t e mo f A c c o u nts provides basic account descriptions, instructions, and accounting definitions, and is particularly important in determining the appropriate cost of property and depreciation for ratemaking purposes. 18 C.F.R. pt. 101.
18 17
See Chapter 8 of this Handbook for a discussion of Transmission and Interconnection compliance issues. Chapter 10 of this Handbook provides a detailed discussion of the Standards of Conduct. Examples of audits concerning the Standards of Conduct are discussed below. See infra notes 24-29 and accompanying text. Chapter 11 of this Handbook provides a detailed discussion of compliance issues related to Codes of Conduct and explains their relationship to Standards of Conduct. On September 1, 2005, FERC instituted a rulemaking on mandatory electric reliability standards. Rules Concerning Certification of the Electric Reliability Organization; and Procedures for the Establishment, Approval, and Enforcement of Electric Reliability Standards, Notice of Proposed Rulemaking, 112 FERC 61,239 (2005). Among other things, the Commission stated that it would be conducting compliance audits of the Electric Reliability Organization and Regional Entities. Id. at PP 39, 74-75. See, e.g., Westar Energy, Inc., 111 FERC 61,225 (2005) (requiring revised internal compliance procedures, training programs and internal compliance audits flowing from staff findings of improper sharing of non-public transmission information with marketing affiliate and failure of
23 22 21 20
19
FERC AUDITS AND INVESTIGATIONS
25
Simultaneously, as discussed below, OMOI has conducted operations audits of other companies involving the same subject matter and sometimes involving monetary remedies. However, as a general proposition, investigations appear more likely to be triggered by specific allegations or concerns raised about a particul a r c o m p a n yb r o u g h t t oF E R C s o r O MO I sa t t e n t i o nb yc u s t o m e r so rc o m p e t i t o r s .A u d i t s , i nt u r n , a p p e a rm o r el i k e l yt o involve generic compliance areas that FERC is raising with all companies. For example, in February 2005, OMOI commenced (with some fanfare) detailed Standards of Conduct audits under the new Order No. 2004 regulations, with the stated goal of ascertaining whether transmission providers are complying with the new rules.24 Beyond that distinction, the principal difference between an OMOI investigation and an OMOI audit appears to be the degree of non-public status. Both investigations and audits are conducted by OMOI staff, using the same investigatory tools (such as data requests, interviews, site visits, and depositions). Further, FERC deems files compiled by OMOI during investigations and audits to be equally non-public. With investigations, however, only the target company is aware of the existence of the investigation and, if the case is not ultimately set for hearing or does not become the subject of a consent agreement, the existence of the investigation remains permanently non-public. Conversely, when OMOI commences a compliance audit, a letter to the company announcing the audit is posted on the FERC Internet site. Possibly because the public is notified that an audit is underway, OMOI audits typically (but not always) conclude with a public report. (OMOI's established practice is always to provide first a non-public draft to the company for its comments.) Audit reports have become a major enforcement tool, as OMOI will push a company to accept Staff proposals as a means of resolving an audit without official Commission action. For example, on December 18, 2003, OMOI published a series of audit reports for utilities in the Pacific N o r t h w e s t t h a t c a t a l o g u e dp e r c e i v e dd e f i c i e n c i e s w i t he a c hu t i l i t y s compliance with Standards of Conduct and OASIS requirements.25 Each report also
transmission provider and affiliate to function independently); Dominion Resources, Inc., 108 FERC 61,110 (2004) (ordering $4.5 million in refunds and a $500,000 civil penalty in response to staff findings of unauthorized communication of non-public information to favored affiliated and nonaffiliated customers); Cleco Corp., 104 FERC 61,125 (2003) (ordering $2 million in refunds and a $750,000 civil penalty in response to staff findings of various violations of the FPA, the OATT, the Standards of Conduct, and FERC Codes of Conduct); Idaho Power Co., 103 FERC 61,182 (2003) (refunding $203,000 to ratepayers and transferring $5.8 million from competitive affiliate to regulated utility for benefit of ratepayers, in response to staff findings of various FPA, OATT, and Standards of Conduct violations). For a summary of settlements of cases involving alleged Standards of Conduct, Code of Conduct and transmission-related violations, see the chart produced at the end of Chapter 10. See Federal Energy Regulatory Commission Open Public Meeting, Jan. 19, 2005, Transcript at 39-43. See Avista Corp., Audit Report, Docket No. PA04-4-000 (Dec. 18, 2003); Bonneville Power Admin., Audit Report, Docket No. PA04-7-000 (Dec. 18, 2003); British Columbia Hydro & Power Auth., Audit Report, Docket No. PA04-6-000 (Dec. 18, 2003); Idaho Power, Audit Report, Docket No. PA04-1-000 (Dec. 18, 2003); NorthWestern Energy, Audit Report, Docket No. PA03-18000 (Dec. 18, 2003); PacifiCorp, Audit Report, Docket No. PA04-5-000 (Dec. 18, 2003); Portland
25 24
26
indicated that the utility agreed to take certain future steps to bring their practices into compliance or , p e r h a p s m o r ep r o p e r l y , i n t oO MO I s v i e wo f compliance. Similarly, on J a n u a r y 2 1 , 2 0 0 5 , O MO I i s s u e d a r e p o r t o n D u k e E n e r g y s c o m p l i a n c e w i t h t h e S t a n d a r d s o f C o n d u c t , m a k i n gf i n d i n g s o f n o n c o m p l i a n c e , r e c o m m e n d i n g c o r r e c t i v e a c t i o n , a n d s t a t i n g Duke's agreement or acquiescence. 26 This occurred informally, without express action by the Commission although it is highly unlikely that OMOI would press any positions for which it did not have the backing of the full Commission, or at least the Chairman.27 In addition, the Commission may choose to formally adopt an audit report. For example, in December 2004, the Commission adopted audit reports relating to Arizona Public Service and Tucson Electric that found Standards of Conduct and transmission-related violations.28 The Commission-a p p r o v e da u d i t r e p o r t sa l s om e m o r i a l i z e dt h ec o m p a n i e s a g r e e m e n t t oe n g a g ea n i n d e p e n d e n t t r a n s m i s s i o nm o n i t o r , u n d e r t a k ev a r i o u sq u a r t e r l y reporting to FERC or OMOI, and (in the case of Arizona Public Service) the payment of $4 million $1.25 million to low income energy assistance programs and $2.75 million for transmission upgrades. Similarly, in May 2005, the Commission approved an OMOI audit report relating to Progress Energy.29 Progress Energy agreed to revise its internal organization and certain business practices as well as provide a $6.4 million refund/credit to its regulated retail and wholesale customers. The Arizona Public Service, Tucson Electric, and Progress Energy audit reports are similar in organization and structure to the abovedescribed audit reports for the Pacific Northwest utilities and Duke Energy (and subsequent OMOI reports issued to date as part of OMOI's Order No. 2004 audits),30 each case containing audit findings and recommendations agreed to by the audited companies. But while the Pacific Northwest utilities and Duke Energy audit reports were issued by the Director of OMOI, the Arizona Public Service, Tucson Electric, and Progress Energy audit reports were formally approved by Commission orders (and discussed at the Commission meetings at which the orders were voted upon). The Commission's adoption of the reports, combined with the monetary remedies agreed to by the companies, make the outcome of such audits appear very similar to consent agreements resolving a non-public investigation. Another possible outcome to an audit and one also reflecting similarity to the outcome of an investigation i sr e f l e c t e db yF E R C sD e c e m b e r2 0 0 4o r d e ri n v o l v i n g 31 Entergy Corporation. In that order, FERC instituted a proceeding under FPA section 206
Gen. Elec., Audit Report, Docket No. PA04-2-000 (Dec. 18, 2003); Puget Sound Energy, Inc., Audit Report, Docket No. PA04-3-000 (Dec. 18, 2003).
26 27
See Duke Energy Corp., Audit Report, Docket No. PA03-15-000 (Jan. 21, 2005).
As discussed above, the Director of OMOI reports directly to the Chairman. Further, draft audit (and investigation) reports are regularly shared by OMOI with the Chairman and other Commissioners. Arizona Pub. Serv. Co., 109 FERC 61,271 (2004); Tucson Elec. Power Co., 109 FERC 61,272 (2004).
29 30 31 28
See Florida Power Corp., 111 FERC 61,243 (2005). See supra note 23 and accompanying text. See Entergy Servs., Inc., 109 FERC 61,281 (2004)
27
32 r e l a t i n gt oE n t e r g y s A v a i l a b l e F l o w g a t e C a p a b i l i t y ( A F C ) m e t h o d o l o g y . FERC set the matter for hearing in part because an audit report issued by OMOI with respect to the predecessor to Ente r g y sA F Cm e t h o d o l o g y E n t e r g y sG e n e r a t o rO p e r a t i n gL i m i t s ( G O L s ) c o n c l u d e dt h a t t h e r ew e r es i g n i f i c a n t e r r o r si nE n t e r g y s p e r f o r m a n c eo f t h e GOL and Local Area Limits methodology.33 The FERC order expressly referred to the findings of the audit report and OMOI's concern that similar quality control issues may exist with respect to the AFC methodology. FERC stated that it would include AFC methodology as an issue to be examined under FPA section 206.34 In this instance, the public audit report became a basis for an adjudicatory proceeding in much the same manner as would an internal Staff report to the Commission detailing the results of a non-public investigation.
II.
RESPONDING
TO A FERC AUDIT OR INVESTIGATION
Each FERC audit or investigation will present unique problems, depending on the subject matter and factual circumstances. However, there are some general considerations that will be relevant in responding to most audits or investigations. A. MANAGING THE SCOPE OF THE INVESTIGATION
Company counsel should contact FERC Staff early in the process. When dealing with FERC Staff, it is important to id e n t i f y S t a f f s i n v e s t i g a t i v e p r i o r i t i e s a n d s e e k t o a d d r e s s those first. Companies should not be reluctant to negotiate on the scope of requests and, in particular, the timing of responses. B e c a u s eF E R C si n v e s t i g ative authority is very broad, it often will be difficult to create real limits on the scope of a particular investigation or the data requested. Further options for pursuing objections based on claims of irrelevance or undue burden are limited. In particular, direct judicial review of FERC decisions generally is restricted to final orders on the merits,35 and courts generally deem orders initiating investigations or audits to be nonfinal, non-reviewable actions.36 Theoretically, the ultimate self-help remedy for a company that believes a FERC data request during an investigation or audit to be unlawful is noncompliance, forcing the agency itself to seek judicial injunctive relief. However, such a strategy carries risks, such as making the agency less willing to consider settlement or consent decrees later in the process and increasing the visibility of the investigation by forcing the agency to make it public through judicial proceedings. For one thing, if FERC is forced to take public action during otherwise non-public (or at least
32 33 34 35
Id. at PP 47-49. Id. Id. at PP 50-51.
See FPC v. Metropolitan Edison Co., 304 U.S. 375, 384 (1938) (construing FPA section 313, 16 U.S.C. 825l, governing judicial review by the courts of appeals).
36
See Niagara Mohawk Power Co. v. FPC, 538 F.2d 966, 970 (2d Cir. 1976).
28
unpublicized) audits or investigations, that will highlight the existence of the audit or investigation, which in turn can cause investor uncertainty. More fundamentally, requiring FERC to compel data production through subpoenas or injunctions raises the question of cooperation with FERC investigators. In addition to fostering the sense that the company has nothing to hide, cooperation (or perceived lack of cooperatio n ) w i t hi n v e s t i g a t o r y o r a u d i t S t a f f i s p a r t o f F E R C s e q u a t i o nw h e nd e t e r m i n i n g appropriate remedies. This is made explicit in FERC s recent Enforcement Policy Statement,37 where the agency states: Lack of cooperation is a serious matter and will be weighed in deciding appropriate remedies. Uncooperative conduct includes such things as failing to respond to data requests in a timely manner; failing to produce documents and witnesses within a reasonable period; misrepresenting the nature or extent of the misconduct; claiming that records are unavailable when they are; limiting staff access to employees; inappropriately directing or influencing employees or their counsel not to cooperate fully or openly with the investigation; engaging in obstructive conduct during investigative testimony or interviews; providing specious explanations for instances of misconduct that are uncovered; failing properly to search computer hard drives for documents and electronic images; and failing to provide documents in the way they are maintained in the normal course of business. The manner in which a company approaches cooperation will be an important factor in determining whether, and how much, credit may be given for cooperation.38 This discussion from the Enforcement Policy Statement appears to be a fairly detailed a n dc o n s i d e r e d l a u n d r yl i s t o f a c t i v i t i e sF E R Cd e e m st ob en o n -cooperative. Prudent company counsel is well advised to keep this list in mind during all aspects of a FERC audit or investigation. It appears that some f a c t o r s t h a t F E R Cd e e m s c o o p e r a t i v e m a yi ns o m e i n s t a n c e sr u nc o n t r a r yt oac o m p a n y si n t e r e s t si np r e s e r v i n gi t sl e g a l r i g h t s , s u c ha st h e attorney-client privilege.39 We expect that in each case the balancing of these potentially competing interests will be highly fact specific. B. CONDUCTING AN INTERNAL REVIEW
When company counsel first becomes aware of a FERC investigation or audit, counsel will need to become familiar with the relevant facts (to the extent the focus of the investigation is clear). At a minimum, this entails determining the individuals in the company most likely to have relevant information and meeting with them to discuss the facts.
Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on E n f o r c e m e n t , 1 1 3F E R C 6 1 , 0 6 8( 2 0 0 5 )( Enforcement Policy Statement ) .T h eEnforcement Policy Statement is discussed in more detail in Chapters 1 and 3 of this Handbook.
38 39
37
Enforcement Policy Statement, 113 FERC 61,068 at P 27. See infra notes 46-47 and accompanying text.
29
This will better enable counsel to analyze the risks presented by the audit/investigation. This also will f a c i l i t a t e c o u n s e l s i n t e r n a l d i s s e m i n a t i o n a n d o v e r s i g h t o f d a t a r e q u e s t s . C. DOCUMENT RETENTION
A t a l l t i m e s , c o m p a n y c o u n s e l s h o u l db e f a m i l i a r w i t h t h e i r o w nc o m p a n y s i n t e r n a l record retention policies and schedules, including those regarding emails and phone recordings. In conjunction with that effort, counsel should make sure company retention policies are consistent with the document retention rules of its regulators, including, of course, FERC.40 Once company counsel becomes aware of the existence of a FERC audit or investigation often, but not always, through receipt of the initial data request itself c o u n s e l s h o u l di n i t i a t e a d o c u m e n t f r e e z e w i t h c l e a r w r i t t e n d i r e c t i v e s i n s t r u c t i n gr e l e v a n t personnel to maintain relevant documents, such as existing paper and electronic files (including emails). The directive also should cover backup tapes and records in storage which might otherwise be written over or destroyed. For example, companies typically have automated programs to delete emails after a given time period. Such processes should be identified and suspended. Counsel should follow up on such directives to ensure that company personnel are complying. D. DOCUMENT PRODUCTION
Once the investigation or audit commences, OMOI Staff should be directed to serve all data requests on company counsel. Company counsel should disseminate the requests to appropriate personnel and supervise responsive data and document production. To the maximum degree feasible, companies should attempt to produce documents and data on a rolling basis to show that Staff data requests are being seriously addressed. At this time, all proprietary, commercially sensitive documents should be identified as such, and company counsel should be conversant with FERC s r u l es for designating such documents.41 F o re x a m p l e , F E R C sg e n e r a l p r a c t i c ei st ot r e a t a l l i n f o r m a t i o na n dd o c u m e n t s obtained during the course of an investigation or audit as non-public. Although such information is subject to the disclosure requirements of the Freedom of Information Act ( F O I A ) , F E R C s r e g u l a t i o n s p r o v i d et h a t a n yp e r s o nc o mpelled to produce information may claim that the information, in whole or in part, is exempt from FOIA disclosure, or is otherwise exempt from public disclosure.42 It is best to make such claims when the documents are provided to FERC Staff. Submitting a claim that particular data provided to
This discussion addresses the issue of document retention in the context of audits and investigations. For a broader discussion of document retention issues, see Chapter 20 of this Handbook. 41 See infra section II.G.
42
40
See 18 C.F.R. 1b.20, 388.112.
30
FERC are e x e m p t f r o mF O I Ad i s c l o s u r ep r e s e r v e s t h e c o m p a n y s r i g h t o f p r i o r n o t i c e a n d 43 protest regarding any FERC determination to disclose the material publicly. E. PRIVILEGE
Prior to production, all potentially responsive documents should be reviewed by company counsel to determine whether they are subject to the attorney-client privilege, the doctrine of attorney work product, or other protections such as investigative privilege. Depending on the circumstances, disclosure of such documents to the government may waive the privilege for that document and possibly for the subject matter of the communication. At a minimum, OMOI will require a privilege log identifying each such document being withheld, and counsel should anticipate challenges to the designations. Further, OMOI Staff sometimes assert that their inability to review relevant documents withheld under claims of privilege may preclude them from making a finding that there is no evidence of wrong-doing, on the theory that they have not seen all documents that could support such a conclusion. Beyond that, as the Enforcement Policy Statement makes particularly clear, a comp a n y s p e r c e i v e dl a c ko f c o o p e r a t i o n w i t ha F E R Ca u d i t o r i n v e s t i g a t i o nw i l l b e c o m e a factor in any ultimate Commission assessment of penalties or other sanctions.44 If data requests appear to cover attorney-client privileged documents, work product, or materials that otherwise are protected, a company must carefully balance its need to build trust with Staff and develop a record of cooperation v e r s u s t h e c o m p a n y s l e g i t i m a t e n e e d to preserve its legal rights. The courts may deem the production of otherwise privileged documents to the government, even under a confidentiality agreement, effectively to be an exercise of selective waiver among potential adversaries, which generally is disfavored and leads to full waiver.45 Courts have, however, upheld the preservation of work product protection against third parties under negotiated confidentiality with the government.46 Ultimately, production of privileged documents under any circumstance carries some risk of waiver, and counsel must carefully balance that risk against the competing risk that
43
Id. This is important because the Rules also provide that, even with the normal requirement of confidentiality, the Commission itself may direct or authorize the public disclosure of an investigation. Id. 1 b . 9 .F E R C s r u l e s a l s o p r o v i d e t h a t t h e i n f o r m a t i o n m a y b e m a d e p a r t o f t h e public record during the course of an adjudicatory proceeding, id., which is further reason to make the agency aware of confidentiality claims at an early stage.
44 45
See Enforcement Policy Statement, 113 FERC 61,068 at P 24.
See, e.g., Tennessee Laborers Health & Welfare Fund v. Columbia/HCA Healthcare Corp., 293 F.3d 289, 302-06 (6th Cir. 2002); In re Steinhardt Partners, LP, 9 F.3d 230, 235 (2d Cir. 1993); In re Subpoenas Duces Tecum, 738 F.2d 1367 (D.C. Cir. 1984); Permian Corp. v. United States, 665 F.2d 1214, 1218 (D.C. Cir. 1981); Bowne v. Ambase Corp., 150 F.R.D. 465, 480 (S.D.N.Y 1993). See, e.g., McKesson HBOC, Inc. Secs. Litig., No. 99-cv-20743, 2005 WL 934331, at *11 (N.D. Cal. March 31, 2005); compare Leslie Fay Cos. Sec. Litig., 152 F.R.D. 42 (S.D.N.Y. 1993) (voluntary disclosure of work product to the government waives the privilege where the company has failed to execute a confidentiality agreement with the government).
46
31
unwavering assertion of the privilege may be held against the company by OMOI (and the FERC). With this in mind, a company should consider whether creative approaches can be structured to maintain cooperation with OMOI while maintaining relevant protections. For its part, hopefully the Commission will understand that its taking of an aggressive stance of requiring waiver of the privilege has other counterproductive effects and should be avoided or used only rarely. F. SITE VISITS, INTERVIEWS, AND DEPOSITIONS
Company production of documents in response to OMOI data requests often is followed by site visits, usually involving interviews of employees that Staff believe are knowledgeable of the matters under investigation or audit. Typically, these interviews are informal and are not recorded; Staff takes handwritten notes, and so do company counsel. At the same time, Staff may seek to record an interview or, in the case of former employees or third-parties, propose interviews conducted jointly by Staff and company counsel. F E R C s Enforcement Policy Statement identifies production of appropriate personnel for Staff 47 i n t e r v i e w s a s a c o n s i d e r a t i o n i n e v a l u a t i n g t h e l e v e l o f a c o m p a n y s c o o p e r a t i o n . In some instances, Staff may conduct depositions of current or former company personnel. Investigatory depositions, falling outside the scope of formal adjudication, may not automatically be subject to standard procedures of depositions in litigation. For example, in FERC investigations, Staff takes the position, at least with regard to depositions of former company employees, that the company does not, as a matter of course, have the right to be present. Agency practice is to negotiate informal guidelines that may limit the role of company counsel and the availability of transcripts. G. COMPANY INPUT INTO THE OUTCOME OF THE AUDIT OR INVESTIGATION
At some point following an audit or investigation, FERC Staff will make an internal determination as to the next steps. This can range from closing the matter (because of no apparent violation or effective remedy) to recommending that the agency institute formal proceedings against the company that ultimately lead after hearings or formal responsive pleadings by the company to some final agency order. Turning first to non-public investigations, although not compelled to do so, Staff may share its conclusions with the company and even permit a written response prior to submitting any investigatory report to agency decision-makers. 48 Further, at any time during the investigation, the company may submit documents, statements of facts, or memoranda of law for the purpose of explaining its position or furnishing evidence. T h i s t y p e o f w r i t t e n r e s p o n s e c a n s e r v e t h e p u r p o s e o f m a k i n g a c a s e to FERC Staff or the agency. Staff will analyze all written submissions before making any recommendations. Even when Staff recommends that FERC institute formal proceedings, S t a f fa l s ow i l l s u m m a r i z et h ec o m p a n y sp o s ition and data responses for the agen c y s
47 48
Enforcement Policy Statement, 113 FERC 61,068 at P 27. See supra note 16 and accompanying text.
32
b e n e f i t . Wh i l eS t a f f m a ys e e kt or e b u t t h ec o m p a n y sp o s i t i o n , S t a f f ss u m m a r yo f t h e c o m p a n y sp o s i t i o nw i l l o r d i n a r i l yb ea c c urate Staff does not wish the agency to be surprised by later arguments. Based on all the above, the agency or Staff will determine how to proceed.49 T u r n i n gt oa u d i t s , F E R C sr u l e sc u r r e n t l yp r o v i d et h a t w i t hr e s p e c t t o f i n a n c i a l audits, if the subject company disagrees with audit findings, it has the opportunity, prior to issuance of a Commission order on the merits, to formally challenge Staff's findings either through so-c a l l e d s h o r t e n e dp r o c e d u r e basically, a paper hearing or a full-fledged hearing before an administrative law judge.50 However, these procedures expressly have applied only to financial audits, and have not been used for so-c a l l e d o p e r a t i o n a l a u d i t s . Wi t ho p e r a t i o n a l a u d i t s , t h ep r a c t i c eh a s been that FERC Staff communicates its audit findings and proposed remedies to the company in draft form, and the company is given a certain number of days to submit written comments (or challenges to findings or proposed remedies). Following receipt of the comments and subsequent discussions with the company, OMOI typically issues a public report, often containing recommendations to which the company has committed. However, on October 20, 2005, in conjunction with its Enforcement Policy Statement, FERC issued a notice of p r o p o s e dr u l e m a k i n gt h a t w o u l df o r m a l i z et h ep r o c e d u r e sf o ro p e r a t i o n a l a u d i t s( A u d i t 51 N O P R ) . Under the Audit NOPR, the rules would be amended to cover all operational a u d i t s u n d e r t h e F P A( a s w e l l a s a u d i t s u n d e r F E R C s j u r i s d i c t i o n a l a u t h o r i t i e s o v e r n a t u r a l gas companies and oil pipelines). Under the proposed rules, where the audit target has communicated its disagreement with any finding or proposed remedy, FERC would notice the dispute without ruling on the merits. The audited person would then have the right to challenge the noticed findings and proposed remedies through shortened procedure or trial52 t y p e h e a r i n g , a l o n g w i t h o t h e r i n t e r e s t e d e n t i t i e s . It is not yet clear the degree to which these new audit rules, if adopted, will affect actual practice under FERC operations audits. While the proposed rules would more clearly s p e l l o u t a t a r g e t c o m p a n y s p r o c e d u r a l r i g h t s p r i o r t othe issuance of a merits order, it does not appear that FERC plans to change its current practice, whereby Staff shares non-public draft audit findings with target companies and discusses them in non-public communications.53
In certain situations where the company believes OMOI Staff seriously misunderstands the facts or may not clearly be explaining the matter to agency decision-makers, the company may also consider directly contacting higher agency officials. 50 See 18 C.F.R. pt. 41. Under either procedure, submissions can be made by other interested parties. Procedures for Disposition of Contested Audit Matters, Notice of Proposed Rulemaking, 113 FERC 61,069 (2005).
52 53 51
49
Id. at PP 7-9. Id. at P 8.
Chapter 3 Civil and Criminal Penalties Under the Federal Power Act
GERALD RICHMAN
1 T h eE n e r g yP o l i c yA c to f2 0 0 5( E P A ct 2 0 0 5 ) significantly increased criminal penalties for violations of statutes administered by the Federal Energy Regulatory Commission ( F E R C o r C o m m i s s i o n )a n da l s oe x p a n d e dt h eC o m m i s s i o n sa u t h o r i t yt oa s s e s sc i v i l penalties for violations of those statutes. While FERC has not yet tested the limits of this new authority, the new authority was provided at least in part because FERC Commissioners felt a need for it.2 Thus, the new penalty provisions clearly raise the stakes for noncompliance with FERC rules and regulations. Indeed, FERC itself has alluded to its enhanced penalty authority as a further reason for regulated companies to have in place comprehensive compliance programs. 3
I. A. CRIMINAL PENALTIES
VIOLATIONS OF THE FEDERAL POWER ACT
Section 316 of the F e d e r a l P o w e r A c t ( FPA ) i m p o s e s c r i m i n a l p e n a l t i e s o n a n y p e r s o n who willfully and knowingly does or causes or suffers to be done any act f o r b i d d e n b y t h e F P A , o r w h ow i l l f u l l y a n d k n o w i n g l y o m i t s o r f a i l s t o d oa n y a c t r e q u i r e db y t h e F P A , o r w i l l f u l l y 4 a n dk n o w i n g l yc a u s e so rs u f f e r ss u c ho m i s s i o no rf a i l u r e . This section applies to both individuals and corporations5 and it extends t ov i o l a t i o n so f a n yr u l e , r e g u l a t i o n , r e s t r i c t i o n , 6 c o n d i t i o n , o r o r d e r m a d e o r i m p o s e d b y t h e C o m m i s s i o n u n d e r a u t h o r i t y o f [ t h e F P A ] . Under
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 2000, Mr. Richman served as an attorney in the Enforcement Section of the Office of the General Counsel at the Federal Energy Regulatory Commission. At Skadden, Mr. Richman has regularly assisted energy companies responding to FERC audits and investigations.
1 2
Pub. L. No. 109-58, 119 Stat. 594 (2005).
F o r e x a m p l e , C o m m i s s i o n e r ( n o wC h a i r m a n ) J o s e p hK e l l i h e r w r o t e t h a t F E R C s i n a b i l i t y t o assess civil penalties for all Part II violations, as well as the $ 1 0 , 0 0 0 p e r d a y c a p , w a s a s e v e r e h a n d i c a p i nt h e C o m m i s s i o n se n f o r c e m e n t o f m a r k e t r u l e s . J o s e p hT . K e l l i h e r , Market Manipulation, Market Power, and the Authority of the Federal Energy Regulatory Commission, 26 ENERGY L.J. 1, 23 (2005). Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 1 1 3 F E R C 6 1 , 0 6 8 , a t P P2 , 2 2 ( 2 0 0 5 ) ( Enforcement Policy Statement ) .
4 5 3
16 U.S.C. 825o(a) (2004).
T h eF P Ad e f i n e sa p e r s o n a s a ni n d i v i d u a l o r c o r p o r a t i o n . Id. 796(4). The term c o r p o r a t i o n d o e s n o t i n c l u d e m u n i c i p a l i t i e s . See id. 796(3). Id. 8 2 5 o ( b ) .S e c t i o n3 1 6s i m i l a r l yc r i m i n a l i z e st h ev i o l a t i o no f a n yr u l eo r r e g u l a t i o n i m p o s e d b y t h e S e c r e t a r y o f t h e A r m y i s s u e d u n d e r t h e p r o v i s i o n s g o v e r n i n g hydroelectricity in Part I of
6
34
EPAct 2005, the potential sanctions for such violations were dramatically increased to include fines of up to $1,000,000 (up from $5,000) and terms of imprisonment for up to five years (up from two), as well as an additional $25,000 per day (up from $500) for a continuing violation.7 Evidence of criminal violations is referred to the Department of Justice for prosecution. 8 B. CIVIL PENALTIES In addition to the criminal penalties set forth in FPA section 316, the Commission also has the independent authority to impose civil penalties for violations of the FPA. As a general matter, FPA section 315 permits the Commission to impose a penalty of $1,000 on any licensee or public utility which willfully fails, within the time prescribed by the Commission, to comply with any order of the Commission, to file any report required under [the FPA] or any rule or regulation of the Commission thereunder, to submit any information or document required by the Commission in the course of an investigation conducted under [the FPA], or to appear by an officer or agent at any hearing or investigation in response to a subpoena issued under [the FPA].9 This relatively minor blanket penalty authority for deliberate violations of explicit Commission directives is different from, and supplemental to, the more specialized authority the Commission has to punish violations under FPA Part I and FPA Part II. In contrast to those other penalty provisions, which do not require a specific intent by the violator, FPA section 315 requires that a v i o l a t i o nb e w i l l f u l a n di ti sp r i m a r i l yd i r e c t e da tc o r p o r a t ee n t i t i e s ,r a t h e rt h a nb o t h 10 corporations and individuals. FPA section 31 allows the Commission to impose penalties of up to $10,000 per day for violations of any order, license or exemption issued under the hydroelectricity provisions of FPA Part I.11 Prior to the enactment of EPAct 2005, violations of the statutes and rules governing wholesale power sales and electric transmission service under FPA Part II were comparatively l i m i t e d .F P As e c t i o n3 1 6 Ap r e v i o u s l yr e s t r i c t e dt h eC o m m i s s i o n s a u t h o r i t yt oi m p o s ec i v i l penalties up to $10,000 per day for violations of only four sections of FPA Part II.12 However,
the FPA. Id. Criminal penalties were not previously available for violations of the four enumerated sections of FPA Part II punishable exclusively through civil penalties, but those violations are now punishable as crimes under EPAct 2005. See infra note 12.
7 8
EPAct 2005, 1284(d), 119 Stat. at 980 (amending 16 U.S.C. 825o(a)). 16 U.S.C. 825m(a); see also Enforcement Policy Statement, 113 FERC 61,068 at P 4 n.5, 16 U.S.C. 823b(c).
P 5 n.10.
9 10
F P As e c t i o n3 1 5a u t h o r i z e s p e n a l t i e s a g a i n s t a l i c e n s e e o r p u b l i c u t i l i t y a n dc a nb e l e v i e d against an individual only if that individual happens to be a hydroelectric licensee. See id. 796(5) ( d e f i n i n g t h e t e r m l i c e n s e e ) .
11 12
See id. 823b.
B e f o r e t h e e n a c t m e n t o f E P A c t 2 0 0 5 , t h e C o m m i s s i o n s a u t h o r i t yt oi m p o s e c i v i l p e n a l t i e s was limited to rules and orders issued under the following statutes: (i) FPA sections 211 and 212, 16 U.S.C. 824j & 824k, concerning mandated wheeling and interconnections; (ii) FPA section 213, 16
CIVIL AND CRIMINAL PENALTIES
35
s e c t i o n 1 2 8 4 ( e ) o f E P A c t 2 0 0 5 g r e a t l y e x p a n d e d t h e C o m m i s s i o n s a u t h o r i t y t o i m p o s e p e n a l t i e s for violations of statutes under FPA section 316A in the following manner: First, FPA section 316A now covers violations of any provision of FPA Part II, including any implementing rule, regulation, or order issued thereunder.13 Second, the penalty ceiling under FPA section 316A has been raised from $10,000 to $1,000,000 for each day for each violation. 14 In addition, in its recent Enforcement Policy Statement, which lays out the factors FERC will take into account in determining remedies for violations, the Commission makes clear that civil penalties may be assessed in addition to other remedies it may impose for a single violation. T h u s , F E R C s e n h a n c e d c i v i l p e n a l t y a u t h o r i t y [ u n d e r E P A ct 2005] will operate in tandem with [its] existing authority to require disgorgement of unjust profits obtained through misconduct and/or to condition, suspend, or revoke . . . market-based rate authority for sellers of electric 15 e n e r g y . I n d e e d , c o m p a n i e s w i l l b e e x p e c t e d t o d i s g o r g e u n j u s t p r o f i t s w h e n e v e r t h e y c a n b e 16 d e t e r m i n e do rr e a s o n a b l ye s t i m a t e d . In other words, a FERC decision to impose civil penal t i e s w i l l n o t , i nt h e a g e n c y s j u d g m e n t , p r e c l u d e t h e s i m u l t a n e o u s d i s g o r g e m e n t o f p r o f i t s and other remedies.17
U.S.C. 824l, concerning information requirements for responses to requests for wholesale transmission service, and (iii) FPA section 214, 16 U.S.C. 824m, concerning rates charged by exempt wholesale g e n e r a t o r s( E WG s ) . See 16 U.S.C. 825o-1(a) (2004). Violations of these four statutes were punishable only through civil penalties under FPA section 316A and could not be punished as crimes under FPA section 316. See id. 825o(c). These violations are now punishable through both kinds of sanctions. See EPAct 2005, 1284(d)(3) (striking 16 U.S.C. 825o(c)).
13 14
See EPAct 2005 1284(e)(1), 119 Stat. at 980 (amending 16 U.S.C. 825o-1(a)).
See id. 1284(e)(2), 119 Stat. at 980 (amending 16 U.S.C. 825o-1(b)). EPAct 2005 s i m i l a r l ya u g m e n t e dF E R C s c i v i l p e n a l t ya u t h o r i t yu n d e r t h eN a t u r a l G a s A c t ( N G A ) .P r e v i o u s l y , F E R Ch a d a u t h o r i t y t o i s s u e c i v i l p e n a l t i e s s o l e l y f o r v i o l a t i o n s o f t h e N a t u r a l G a s P o l i c y A c t ( N G P A ) , a statute that a l l o w s ( u n d e r s o m e c i r c u m s t a n c e s ) i n t e r s t a t e n a t u r a l g a s p i p e l i n e s t op r o v i d e s e r v i c e s o n b e h a l f o f i n t r a s t a t e n a t u r a l g a s p i p e l i n e s ( a n dvice versa). However, the principal statute that governs FERC regulation of the natural gas industry and the equivalent statutory scheme to the FPA is the NGA. Prior to passage of EPAct 2005, FERC lacked any authority to impose civil penalties under NGA, see Coastal Oil & Gas Corp. v. FERC, 782 F.2d 1249 (5th Cir. 1986). However, section 314 of EPAct 2005 added a new section 22 to the NGA that allows FERC to impose a civil penalty of $1,000,000 per day for any violation of the NGA or any rule, regulation or order issued by FERC under the NGA. See EPAct 2005 314(b), 119 Stat. at 961 (renumbering NGA sections 22 through 24 and creating a new section 22 codified at 15 U.S.C. 717t-1). Enforcement Policy Statement, 1 1 3F E R C 6 1 , 0 6 8a t P1 2 .F E R Ci n t e n d s t ot a k e t h e f u l l range of possible remedies into account in determining whether a penalty should be imposed in addition t o o t h e r r e m e d i e s a n d , i f s o , t h e a p p r o p r i a t e a m o u n t o f t h e p e n a l t y . Id.
15 16 17
Id. at P 19.
I n t h a t r e g a r d , i t l o n g h a s b e e n h e l d t h a t F E R C s d i s c r e t i o n i s a t i t s z e n i t h when fashioning remedies. See, e.g., Niagara Mohawk Power Corp. v. FPC, 379 F.2d 153, 159 (D.C. Cir. 1967).
36
A t t h es a m et i m e , t h e s ee x t r a o r d i n a r yi n c r e a s e si nt h eC o m m i s s i o n sp e n a l a u t h o r i t y under the new FPA section 316A are tempered somewhat in several ways. Most generally, the e x p a n s i o n o f F E R C s j u r i s d i c t i o n t o i m p o s e p e n a l t i e s d o e s n o t c h a n g e t h e g e n e r a l r e q u i r e m e n t o f t h e A d m i n i s t r a t i v e P r o c e d u r e A c t ( A P A ) t h a t , i n i s s u i n g s u c h p e n a l t i e s , F E R Cm u s t engage in reasoned decisionmaking and reach conclusions supported by substantial evidence in the record.18 More explicitly, in amending the civil penalty provisions of section 316A Congress retained l a n g u a g e r e q u i r i n g F E R Ct o t a k e i n t o c o n s i d e r a t i o n t h e s e r i o u s n e s s o f t h e v i o l a t i o n a n d 19 the efforts o f s u c h p e r s o n t o r e m e d y t h e v i o l a t i o n i n a t i m e l y m a n n e r . With respect to the first factor retained in section 316A(b) determining the seriousness of the offense the Enforcement Policy Statement lists seven groups of factors that FERC will assess to determine whether and to what extent it will impose remedies other than disgorgement of unjust profits, including civil penalties and/or suspension/revocation of market-based rate authority.20 These seven groups of factors some of which contain multiple distinct elements are set out in full below: What harm was caused by the violation? Was there loss of life or injury or endangerment to persons? Was there damage to property or the environment? Was the harm widespread across markets or customers, or was it limited in scope and impact? Did it involve significant sums of money? Were others indirectly affected by the wrongdoing? What benefit did the wrongdoer gain from the violation? Was the violation the result of manipulation, deceit, or artifice? Did the wrongdoer misrepresent material facts? Was the conduct fraudulent? Were the actions reckless or deliberately indifferent to the results? Was the action willful? Was the violation part of a broader scheme? Did the wrongdoer act in concert with others?
FPA section 31(d)(2)(B) expressly adopts the standards for reasoned decisionmaking set forth in the APA, see 16 U.S.C. 823b(d)(2)(B), and federal appellate courts have vacated civil penalties imposed by the Commission that violated that standard. See, e.g., Clifton Power Corp. v. FERC, 88 F.3d 1258 (D.C. Cir. 1996) (vacating civil penalty against hydroelectric licensee under FPA Part I where FERC failed to consider the impact of violations by other entities, fa i l e d t o c o n s i d e r t h e v i o l a t o r s l a c k o f gain through non-compliance, and failed to explain its reliance on gross income, rather than net income, i na s s e s s i n gt h ev i o l a t o r s a b i l i t yt op a y ) ; Bluestone Energy Design, Inc. v. FERC, 74 F.3d 1288, 1295 (D.C. Cir . 1 9 9 6 ) ( v a c a t i n g o r d e r w h e r e C o m m i s s i o n h a d i m p r o p e r l y c o n s i d e r e d s t a f f t i m e a n d r e s o u r c e s i ns e t t i n gap e n a l t y ) .F P As e c t i o n3 1 6 Aa d o p t s t h i s s a m es t a n d a r db yc r o s s -referencing FPA section 31(d), and this reference was not changed under EPAct 2005. See 16 U.S.C. 825o-1(b) (2005); see also 18 C.F.R. 385.1505 (2005) (listing eleven factors the Commission considers in imposing civil penalties under FPA section 31).
19 20
18
16 U.S.C. 825o-1(b).
See Enforcement Policy Statement, 113 FERC 61,068 at PP 19-20. Note that the Enforcement Policy Statement e m p h a s i z e s t h a t n o l i s t c a n c o v e r e v e r y s i g n i f i c a n t f a c t o r , t h a t F E R Cw i l l c o n s i d e r o t h e r p e r t i n e n t f a c t o r s a s a p p r o p r i a t e , a n dt h a t t h e [ Enforcement] Policy Statement does not confer any rights or g u a r a n t e e s w i t h r e s p e c t t o e n f o r c e m e n t a c t i o n s . Id. at PP 17-18.
37
Is this a repeat offense or does the company have a history of violations? Is this an isolated instance or a recurring problem? Was the wrongdoing systematic and persistent? How long did the wrongdoing last? Was the wrongdoing related to actions by senior management, the result of pressure placed on employees by senior management to achieve specific results, or done with the knowledge and acquiescence of senior management? Did management engage in a cover-up? How did the wrongdoing come to light? Did senior management resist or ignore efforts to inquire into actions or otherwise impede an inquiry into the violation? What effect would potential penalties have on the financial viability of the company that committed the wrongdoing?21 Some of the above factors, such as a history of violations and the response of senior management, point to the importance of internal compliance procedures. This becomes explicit when the Enforcement Policy Statement addresses the second factor that section 316A(b) mandates in determining the amount of any civil penalty efforts of the company to remedy the violation in a timely manner. The Enforcement Policy Statement deems this element to involve three related aspects: internal compliance, self-reporting, and cooperation with the agency. 22 These aspects of the Enforcement Policy Statement are addressed in Chapter 1 of this handbook. C. AN ILLUSTRATIVE EXAMPLE OF POTENTIAL PENALTIES UNDER EPACT 2005 An example may be helpful in understanding the increased penalty exposure under EPAct 2 0 0 5 , a n di np a r t i c u l a r t h e r i p p l e e f f e c t t h a t c a nf l o wf r o m as i n g l ec o m p l i a n c em i s t a k e .I n this example, we will look at the possible fallout from a misclassification of a single employee 23 u n d e r F E R C s S t a n d a r d s o f C o n d u c t and Codes of Conduct.24 It is common for an employee in a h o l d i n g c o m p a n y s y s t e mt o b e c l a s s i f i e d , f o r S t a n d a r d s o f C o n d u c t p u r p o s e s , a s b e i n g s h a r e d between an electric Transmission Provider and an Energy Affiliate, and for Code of Conduct purposes, as being sha r e db e t w e e na r e g u l a t e d f r a n c h i s e du t i l i t y( t h e T r a n s m i s s i o nP r o v i d e r ) a n d a c o m p e t i t i v e o r u n r e g u l a t e d p o w e r m a r k e t e r ( t h e E n e r g y A f f i l i a t e ) . Wh e n a n e m p l o y e e is classified as shared, no information sharing restrictions pertain, and that employee subject to a n oc o n d u i t rule25 may receive, for example, daily email reports on transmission conditions from the Transmission Provider. In our example we will assume the existence of one such employee who receives one such email each day.
21 22 23
Id. at P 20. Id. at PP 22-27.
The Standards of Conduct are codified at 18 C.F.R. Part 358. For a detailed discussion of the Standards of Conduct, see Chapter 10 of this Handbook.
24 25
Codes of Conduct are discussed in Chapter 11 of this Handbook. I n C h a p t e r s 1 0 a n d 1 1 o f t h i s H a n d b o o k t h e n o c o n d u i t r u l e i s d i s c u s s e d .
38
Now assume t h a tF E R C sO f f i c eo fMa r k e tO v e r s i g h ta n dI n v e s t i g a t i o n( O MO I ) 26 conducts an audit of an electric transmission provider and determines that the employee in question should not have been a shared employee, but rather should have been classified as a marketing employee of the Energy Affiliate/power marketer. Assume further that OMOI concludes that the period of misclassification and receipt of transmission information by daily email endured for a 180-day period following the effective date of the new penalties under FPA section 316A.27 Under these facts, which are hypothetical but not at all far-fetched, 28 this single act of employee misclassification could result in determinations that: The Transmission Provider did not prevent Energy Affiliate employee access to nonpublic transmission information (a violation of section 358.5(a) of the Standards of Conduct); The Transmission Provider disclosed non-public transmission system information to an Energy Affiliate employee (a violation of section 358.5(b)).29 T h e E n e r g yA f f i l i a t e e m p l o y e e d i dn o t f u n c t i o ni n d e p e n d e n t l yf r o mt h ec o m p a n y s transmission function employees (a violation of section 358.4(a)(1)). The Energy Affiliate employee was improperly identified on the organizational charts posted by the company on OASIS (a violation of section 358.4(b)(3)(ii)). T h e c o m p e t i t i v e E n e r g yA f f i l i a t ee m p l o y e ef a i l e d( t ot h em a x i m u m e x t e n t p r a c t i c a l ) t o o p e r a t e s e p a r a t e l y f r o m r e g u l a t e d e l e c t r i c u t i l i t y e m p l o y e e s (a standard requirement of FERC-approved Codes of Conduct).30 T h e r e g u l a t e d u t i l i t ya n dt h e c o m p e t i t i v e E n e r g yA f f i l i a t es h a r e dn o n p u b l i c market information (another standard Code of Conduct requirement).
26 27
See Chapter 2 of this Handbook for a discussion of OMOI audits and investigations.
F E R C sn e wa n de n h a n c e dcivil penalties are applicable only to violations on and after August 8, 2005. See Enforcement Policy Statement, 113 FERC 61,068 at P 22 n.22. However, to the extent that a previous violation is continuing, the new and enhanced penalties are applicable to that violation as of August 8, 2005. Id. Since OMOI does not audit every company every six months, the actual period of noncompliance may be substantially longer than a 180-day period following the effective date. It might be argued that the a c c e s s a n d d i s c l o s u r e p r o h i b i t i o n s a r e r e a l l y t w o s i d e s o f t h e same coin. Nevertheless, they are listed as separate and distinct prohibitions under the Standards of Conduct.
29 28
Another relatively conservative assumption in our hypothetical is that this employee is shared only with one power marketer affiliate, and that the regulated company does not have its own Code of Conduct, meaning that only one Code of Conduct is violated. If additional power marketing affiliates were involved for example, the c o m p e t i t i v e e m p l o y e e i nq u e s t i o nw o r k e df o r a s e r v i c e o r g a n i z a t i o n t h a t o p e r a t e da l l o f t h e r e g u l a t e d u t i l i t y sm a r k e t i n ga f f i l i a t e s then each marketing affiliate would have its own Code of Conduct, and each also would face potential penalties for each day of violation of each Code of Conduct provision.
30
39
T h e r e g u l a t e d u t i l i t ya n dt h e c o m p e t i t i v e E n e r g yA f f i l i a t ev i o l a t e d Ma r k e t Behavior Rule 6, which prohibits a seller with market-based rate authority from c o l l u d [ i n g ] w i t ha n o t h e r p a r t yi na c t i o n s t h a t v i o l a t e t h e S e l l e r s m a r k e t -based rate code of conduct or . . . standards of conduct, as they may be revised from time to 31 t i m e . Prior to the amend m e n t s t oF P As e c t i o n3 1 6 A , F E R C s p e n a l a u t h o r i t yi ns u c haf a c t scenario was at best unclear, and the ceiling on any violation would have been $10,000 per day. Under the new scheme, however, FERC is authorized to assess a civil penalty of up to $1,000,000 per day for each violation of any provision of any rule or order issued pursuant to Part II of the FPA. Under the above scenario, if all the above violations were treated as a single violation for civil penalty purposes, the maximum theoretical civil penalty for the entire 180 days would be an astronomical $180,000,000; if each violation were treated as a separate violation leaving aside the possibility of double violations raised by the violation of Market Behavior Rule 6 this already astronomical figure sky-rockets to $1,260,000,000. If by some chance a s m o k i n gg u n m e m oo re m a i lw a sd i s c o v e r e di n d i c a t i n gt h a tt h em i s c l a s s i f i c a t i o nw a s intentional, criminal penalties could be triggered under FPA section 316, and in our postWorldCom society it is no longer inconceivable that such penalties could include large fines as well as jail time for culpable individuals. Indeed, the Enforcement Policy Statement emphasizes t h a t F E R C r e s e r v e s t h e r i g h t t o r e f e r m a t t e r s t o t h e J u s t i c e D e p a r t m e n t f o r c r i m i n al prosecution at the same time that it assess civil penalties for the same conduct.32 Hopefully, FERC would not impose maximum penalties for this type of violation, but even smaller penalties can quickly turn into large numbers when multiplied by a number of violations over a number of days. D. CONCLUSIONS Despite the dramatic increase in the potential civil penalties for violations of the FPA, the good news is that, as noted above, Congress retained language that directs FERC to take into account not only the magnitude of the offense, but also the company s corrective actions.33 In addition, the Enforcement Policy Statement reflects a recognition by the Commission of the need to tailor civil penalties to the facts and circumstances of each particular case. It therefore seems unlikely that FERC will exercise maximum penal authority in most cases, particularly in cases
See Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Amending Market-Based Rate Tariffs and Authorizations, 105 FERC 61,218, at App. A (2003). Literally construed, Market Behavior Rule 6 allows a power marketer to be penalized for i t s a f f i l i a t e dT r a n s m i s s i o nP r o v i d e r s S t a n d a r d s o f C o n d u c t v i o l a t i o n s a n da l s oa l l o w s t h e T r a n s m i s s i o n P r o v i d e r t o b e p e n a l i z e df o r i t s E n e r g yA f f i l i a t e s C o d e o f C o n d u c t violations potentially doubling the i m p a c t o f e a c h v i o l a t i o n o n t h e c o m p a n y a s a w h o l e .C o m p l i a n c e i s s u e s u n d e r F E R C s Ma r k e t B e h a v i o r Rules are the subject of Chapter 9 of this Handbook. Note, however, that FERC recently issued an order requesting com m e n t s o n w h e t h e r , g i v e n t h e a g e n c y s e n h a n c e d a u t h o r i t y t o p o l i c e m a r k e t m a n i p u l a t i o n a s a result of EPAct 2005, FERC should repeal the Market Behavior Rules. See Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 113 FERC 61,190 (2005). Enforcement Policy Statement, 1 1 3F E R C 6 1 , 0 6 8a t P1 5 . T h e r e i s n od o u b t t h a t e n t i t i e s and individuals are subject both to prosecution under criminal provisions of our statutes and to civil r e m e d i e s . Id.
32 33 31
See supra notes 18-19 and accompanying text.
40
where the agency will be unable to point to actual harm to energy markets or consumers. At the same time, FERC deliberately sought this increased penal authority notwithstanding that it was regularly able to negotiate multi-million dollar settlements (some in the $20 million range) under the more limited authority it had prior to EPAct 2005.34 So it seems apparent that FERC at least contemplates the possibility of higher penalties, both in the context of formal assessment orders and (through the threat of ultimately high assessment orders) in the context of providing leverage to FERC Staff when negotiating the resolution of investigations and audits with target companies. Based upon the statute and the Enforcement Policy Statement, FERC should view a robust electric company compliance program as a strong mitigating factor in utilizing its new penal authority.35
See, e.g., Dominion Res., Inc., 108 FERC 61,110 (2004) (approving, inter alia, a consent agreement with Columbia Gas Transmission Corp. assessing $2.5 million civil penalty under the NGPA for disclosing non-public storage information to favored customers); Transcontinental Gas Pipeline Corp., 102 FERC 61,302 (2003) (approving a consent agreement assessing $20 million NGPA civil penalty for violations including failure to post discounts, inaccurate posted data, inadequate organization charts, failure to prepare and retain written documentation, and information sharing with affiliate). A chart summarizing such settlements is located at the end of Chapter 10 of this Handbook. Chapter 1 of this Handbook presents a discussion of the basic design of a compliance program under the Enforcement Policy Statement and the Federal Sentencing Guidelines for Organizations.
35
34
Chapter 4 FERC Reporting Requirements

JEFFREY A. SHERMAN Electric utility companies, independent power producers, and independent and affiliated power marketers must file an array of reports at the Federal Energy Regulatory Commission ( FERC or Commission ) on a regular basis. This chapter discusses periodic FERC reporting requirements that electric utilities, independent power producers, and power marketers must adhere to in order to conduct business. 1 With the passage of the Energy Policy Act of 2005 ( EPAct 2005 ),2 which, among other things, expanded the Commission s authority to punish violations of the FPA, including violations of reporting requirements,3 and the FERC s recently issued Enforcement Policy Statement, 4 the need to establish internal controls to ensure compliance with FERC s reporting requirements has increased markedly. I. ELECTRIC UTILITIES
A. FORM NOS. 1 & 1F: ANNUAL REPORTS OF MAJOR AND NON-MAJOR ELECTRIC UTILITIES 1. Requirement to File Form Nos. 1 & 1F All electric utility companies subject to FERC s jurisdiction must file either Form No. 1, for major utilities, or Form No. 1-F, for small utilities. Form Nos. 1 and 1-F are the main annual reports for electric utilities and contain comprehensive financial and operating information. These forms report financial information, balance sheet and income statement
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Sherman joined Skadden in 2000 and has provided regulatory advice to clients on a broad range of issues before FERC. Mr. Sherman has also participated in several significant and lengthy FERC hearings involving both electric and natural gas matters. This chapter is intended to discuss periodic reports required by the Federal Power Act ( F P A )o rF E R C sr e g u l a t i o n s . R e p o r t i n ga n df i l i ng requirements triggered by voluntary applications, such as dispositions of assets, rate filings, or other such filings, are not addressed in this chapter. Entities submitting such applications should be aware of the reporting and filing obligations related to their submissions. This chapter also does not address reporting and filing obligations s p e c i f i c a l l y r e l a t e d t o r e g i o n a l t r a n s m i s s i o n o r g a n i z a t i o n s ( R T O s ) o r i n d e p e n d e n t s y s t e mo p e r a t o r s ( I S O s ) , o r h y d r o e l e c t r i c f a c i l i t i e s .
2 3 1
Pub. L. No. 109-58, 119 Stat. 594 (2005).
See id. 1284(e), 119 Stat. at 980 (amending FPA section 316A, 16 U.S.C. 825o-1). The penalty ceiling has been raised from $10,000 to $1,000,000 per day for each violation. See id. T h e C o m m i s s i o n s n e wp e n a l a u t h o r i t y is discussed in detail in Chapter 3 of this Handbook. Enforcement of Statutes, Orders, Rules and Regulations, Policy Statement on Enforcement, 113 FERC 61,068 ( 2 0 0 5 ) ( Enforcement Policy Statement ) .
4
42
supporting information, and electric plant, sales, operating expenses, and statistical data. Among other things, Form No. 1 information is used in rate cases, in FERC s audit program, and to review the financial condition of regulated companies. Major utilities, which must file Form No. 1, are defined as having in each of the previous three years (1) one million megawatt-hours or more of total sales; (2) 100 megawatt-hours of sales for resale; (3) 500 megawatt-hours of power exchanges delivered; or (4) 500 megawatt-hours of wheeling for others (deliveries plus losses).5 Non-major utilities are those that do not meet the criteria above and that have total annual sales of 10,000 megawatt-hours or more for each of the last three years. 6 FERC generally grants waivers of Form Nos. 1 and 1-F filing requirements to independent and affiliated power marketers and independent power producers, and thus such entities typically are exempt from these reporting requirements. FERC recently considered whether it should continue this exemption, but it decided to address that issue in another proceeding.7 Public utilities required to file Form Nos. 1 and 1-F include those individuals and corporations, as defined in the FPA,8 that own or operate facilities used for wholesale sales of electric energy in interstate commerce, or for transmission of electric energy in interstate commerce.9 Government-owned entities such as municipal utilities, state power agencies, and federal power marketing agencies, are not required to file Forms Nos. 1 and 1-F.10 Furthermore, rural electric cooperatives financed by the Rural Utilities Service ( RUS ) are not considered jurisdictional public utilities under the FPA and generally are not subject to FERC s accounting and reporting requirements.11 However, cooperatives that have repaid their debt to the RUS and that engage in FERC-jurisdictional sales or transmission service
5 6
18 C.F.R. Part 101, General Instructions No. 1(A) (2005).
Id. Utilities below 10,000 megawatt-hours do not have any Form No. 1 or 1-F filing requirements. See Accounting and Reporting of Financial Instruments, Comprehensive Income, Derivatives and Hedging Activities, Order No. 627, 101 FERC 61,032 ( 2 0 0 2 ) ( O r d e r N o . 6 2 7 ) . The rulemaking that led to Order No. 627 initially considered whether the Form Nos. 1 and 1-F exemption for power marketers and independent power producers should be continued. Order No. 627 severed that issue with the intention of addressing it in another proceeding. Id. at P 23. FERC has not yet instituted any such proceeding.
8 9 7
16 U.S.C. 824 (2004).
FERC has held that RTOs and ISOs are public utilities, and, as such, are required to file Form No. 1. See, e.g., PJM Interconnection, L.L.C., 107 FERC 61,087, at P 51 (2004). The FPA generally exempts such government-owned entities from public utility regulation. 16 U.S.C. 824(e). Such entities, however, may be subject to specific provisions of the FPA, such as sec t i o n 2 1 1 ( r e l a t i n g t o F E R C s t r a n s m i s s i o n w h e e l i n g a u t h o r i t y ) . Id. 824j. See Dairyland Power Coop., 37 FPC 12 (1967), a f f ds u bn o m . S a l t R i v e r A g r i c u l t u r a l Improvement & Power Dist. v. FPC, 391 F.2d 470 (D.C. Cir. 1968).
11 10
FERC REPORTING REQUIREMENTS
43
become subject to FERC s jurisdiction, including these reporting requirements.12 Both FERC jurisdictional utilities, as well as government-owned entities and electric cooperatives that are not subject to FERC s jurisdiction, may be required to submit similar or additional reports to the Energy Information Administration ( EIA ) or RUS, if applicable.13 Form Nos. 1 and 1-F information is collected pursuant to sections 304 and 309 of the FPA.14 Form No. 1 was first prescribed in 1937 by FERC s predecessor agency, the Federal Power Commission ( FPC ), and has been revised numerous times since then. Part 101 of FERC s regulations15 sets forth and describes the type of data that must be filed in the accounts in Form Nos. 1 and 1-F. The Forms themselves also provide detailed filing information. The data in the forms must be prepared in conformity with FERC s 16 Uniform System of Accounts ( USOA ). Utilities should be aware of modifications to or interpretations of the USOA as well as changes to schedules and accounts comprising Form No. 1. 2. Recent Changes to FERC Form No. 1 Reporting Requirements a. Changes in Fair Market Value In the wake of the Enron scandal, FERC modified the USOA and Form No. 1 schedules in several significant respects. In Order No. 627, FERC modified Form Nos. 1 and 1-F accounting requirements to require utilities to report changes in the fair value of certain security investments, items of other comprehensive income, derivative instruments, and hedging activities that were not previously addressed in FERC s USOA or Form No. 1.17 Utilities now must report changes in the fair market value of derivative instruments and hedging activities in their Form No. 1. Derivatives used for hedging activities are filed in Accounts 176 and 245 and derivatives used in non-hedging activities are reported in Accounts 175 and 244.18
See, e.g., Central Elec. Coop., Inc., 77 FERC 61,076 (1996). Small utilities generally may seek waivers of FERC filing requirements, although waivers of the Form Nos. 1 or 1-F are unlikely to be granted. For example, Form EIA-412 requires the annual submission to EIA of accounting data s i m i l a r t o F E R C s r e q u i r e m e n t s .See http://www.eia.doe.gov/cneaf/electricity/page/forms.html. This report, however, has been temporarily suspended. Id. For RUS forms, including RUS Form 7 annual Financial and Statistical Report, refer to http://www.usda.gov/rus/electric/forms/. Utilities should review these and other EIA and RUS resources for any such reporting obligations.
14 15 16 13
12
16 U.S.C. 825c & 825h. 18 C.F.R. Part 101.
Id. Section 301(a) of the FPA gives the Commission broad autho r i t yt o p r e s c r i b ea s y s t e mo f a c c o u n t s t o b e k e p t b y p u b l i c u t i l i t i e s . 1 6 U . S . C . 8 2 5 ( a ) .
17 18
See Order No. 627, 101 FERC 61,032 at P 1.
Id. at P 43. The thrust of Order No. 627 was to increase the transparency of jurisdictional e n t i t i e s o p e r a tions and financial performance. In the Order No. 627 Notice of Proposed Rulemaking,
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK b. Cash Management Programs
In Order No. 634-A,19 FERC required FERC-jurisdictional entities that are required 20 to file Form Nos. 1 and 1-F to place any cash management programs in writing, file relevant cash management agreements with FERC, and file any changes to these programs.21 c. Form 3-Q Quarterly Reports In Order No. 646, FERC instituted several significant changes to Form No. 1.22 Most notably, Order No. 646 required the filing of quarterly updates known as Form No. 3-Q. Order No. 646 also greatly expanded the corporate officer certification requirements for Form No. 1, although this requirement has since been deferred indefinitely. 23 Order No. 646 also added a less stringent certification requirement for the new Form No. 3-Q that resembles the prior certification requirement for Form No. 1. Form No. 3-Q and the officer certification requirements are discussed in the next section.
F E R Cs t a t e dt h a t i ft h ee f f e c t so fc e r t a i nd e r i v a t i v ei n s t r u m e n t sa n dh e d g i n ga c t i v i t i e sa r en o t properly reported to the Commission in FERC Annual Reports, it will be difficult for the Commission a n do t h e r st od e t e r m i n et h ee x t e n t a n de f f e c t so f d e r i v a t i v e so naj u r i s d i c t i o n a l e n t i t y sf i n a n c i a l s t a t e m e n t sa n dr e s u l t so fo p e r a t i o n s . Accounting and Reporting of Financial Instruments, Comprehensive Income, Derivatives and Hedging Activities, FERC Stats. & Regs., Proposed Regs., 1999-2003 32,558, at 34,123 (2001). The relevant regulations are located in the General Instructions to 18 C.F.R. Part 101 (Nos. 23 and 24) (accounting for other comprehensive income, derivative instruments, and hedging activities). Regulation of Cash Management Practices, Order No. 634-A, 105 FERC 61,098 (2003) ( O r d e r N o . 6 3 4 -A ) .O r d e r N o . 6 3 4 , t h e p r e d e c e s s o r t o O r d e r N o . 6 3 4 -A, was an interim rule. See Regulation of Cash Management Practices, Order No. 634, 103 FERC 61,351 (2003). C a s hm a n a g e m e n t o r m o n e yp o o l p r o g r a m s a r e t h o s e t h a t c o n c e n t r a t e a f f i l i a t e s c a s h assets in joint accounts for the purpose of providing financial flexibility and lowering the cost of borrowing.
20 19
Order No. 634-A also required affected entities to notify the Commission of certain changes to their proprietary capital ratios, but FERC later dropped this as a separate requirement when it issued Order No. 646. See Quarterly Financial Reporting and Revisions to the Annual Reports, Order No. 646, 106 FERC 61,113, a t P1 0 8( 2 0 0 4 ) ( O r d e r N o . 6 4 6 ) , r e h g , Order No. 646-A, 107 FERC 61,231 (2004). Entities must instead report in the Form Nos. 1 and 3-Q any I m p o r t a n t C h a n g e s t h a t c a u s e t h e p e r c e n t a g eo f their capital structure that constitutes proprietary capital to drop below thirty percent, as well as any plans to regain at least a thirty percent proprietary capital ratio and the extent to which the entity has amounts loaned or advanced to its parent, subsidiary or affiliate through any cash management program. Id. The applicable regulations are found at 18 C.F.R. 141.500.
22 23
21
Order No. 646, 106 FERC 61,113.
See Quarterly Financial Reporting and Revisions to the Annual Reports, Order Delaying Implementation of the Corporate Officer's Certification Statement for FERC Annual Report Forms, 110 FERC 6 1 , 3 0 1( 2 0 0 5 ) .T h e C o m m i s s i o nd e l a y e dt h e i m p l e m e n t a t i o no f t h e c o r p o r a t e o f f i c e r s certification statement for FERC annual report forms until further notice to allow parties to conform t h o s er e q u i r e m e n t s t os i m i l a r S e c u r i t i e s a n dE x c h a n g eC o m m i s s i o n( S E C ) r e q u i r e m e n t s .I nt h e meantime, entities should continue to use the current officer certifications for Form No. 1. Id. at P 7.
45
Order No. 646 also added several new schedules that must be included in Form No. 1 and in the quarterly Form No. 3-Q filings. These include: (i) an Ancillary Services Schedule, which reports the amount of ancillary services purchased, sold, and used for internal purposes during the year, and (ii) a Monthly Transmission Peak Load Schedule, which reports monthly transmission peak (including the utility s own use) as defined in the utility s Open Access Transmission Tariff. Changes to Form No. 1 and the related accounting schedules are generally accomplished through general rulemakings.24 In addition, FERC, either on its own initiative or upon request, may provide formal interpretations concerning its accounting and financial reporting rules and regulations. Interpretations of a general nature are referred to as accounting guidances, while specific interpretations are called Accounting Releases ( ARs ). These formal interpretations are noticed and assigned a docket number beginning with the AI prefix, and can be tracked on FERC s website.25 Affected entities also should be aware of other FERC decisions, such as company-specific proceedings, that may impact the Form 1 accounts and filing requirements. 3. Form Nos. 1 and 1-F: How to File Part 101 of FERC s regulations explains how to file Form Nos. 1 and 1-F and describes the type of data that must be filed in those forms. The regulations are lengthy, and 26 include General Instructions, specific instructions pertaining to electric plant accounts 27 and operating expenses, and a detailed explanation of each balance sheet account included in the forms.28 Utilities should also complete Form Nos. 1 and 1-F pursuant to the instructions on the forms themselves. The filing deadline for both Form Nos. 1 and 1-F is April 18 of each year.29
It should be noted that FERC recently proposed new rules to permit performance-based ratemaking, which, among other things, would also require public utilities to file an annual report specifying for transmission, current and projected transmission investment activity. Promoting Transmission Investment through Pricing Reform, Notice of Proposed Rulemaking, 113 FERC 61,182, at P 15 (2005). The Commission maintains a list of current accounting rulemakings, guidances, and ARs at its website. See http://www.ferc.gov/legal/acct-matts.asp.
26 27 28 25
24
18 C.F.R. Part 101 (General Instructions). Id. (Electric Plant Instructions; Operating Expense Instructions).
Id. (Balance Sheet Accounts 101 through 935). The General Instructions also require utilities to maintain for inspection the books and records supporting their accounting entries. 18 C . F . R . P a r t 1 0 1 , G e n e r a l I n s t r u c t i o n s N o . 2 . P a r t 1 2 5 o f t h e F E R C s R u l e s a n d R e g u l a t i o n s s e t s f o r t h the records retention schedules for utility records and documentation. 18 C.F.R. Part 125 (2005). Chapter 20 of this Handbook d i s c u s s e s F E R C s r e c o r d s r e t e n t i o n r e q u i r e m e n t s i n m o r e d e t a i l .
29
18 C.F.R. 141.1, 141.2.
46
In 2002, FERC issued an order requiring utilities to file Form No. 1 electronically, using specific software developed for the submission of these forms.30 Form No. 1-F may still be submitted in hard copy format. FERC s website contains a blank Form No. 1, 31 electronic filing software, and filing instructions. B. FORM NO. 3-Q: QUARTERLY FINANCIAL REPORTS 1. Requirement to File Form No. 3-Q Order No. 646, issued on February 11, 2004, established a new quarterly reporting requirement for electric utilities, licensees of hydroelectric projects, natural gas pipelines, and oil pipelines.32 These requirements became effective on March 29, 2004. All FERCjurisdictional electric utilities that are required to file Form Nos. 1 and 1-F must also file a Form No. 3-Q Quarterly Report. Form No. 3-Q is intended to be an adjunct to Form No. 1 or Form No. 1-F, and reports comprehensive financial and operating data for the most recent quarter. In addition to requiring quarterly reports, Order No. 646 also added new schedules of information that must be reported on Form No. 1 Annual Reports and Form No. 3-Q Quarterly Reports, and established new corporate officer certification requirements for both reports. The significant new requirements are as follows: Financial Statements for Quarterly Reports. A set of basic financial statements must be included in the quarterly financial reports. These statements are the Comparative Balance Sheet, the Statement of Income and Retained Earnings, the Statement of Cash Flows, and the Statement of Other Comprehensive Income and Hedging Activities. In addition, certain detailed information that is filed with the Commission on an annual basis (in Form Nos. 1 and 1-F) must also be filed on a quarterly basis. The supplemental information includes revenues and the related quantities of product sold or transported, the account balances for various operating and maintenance expenses, selected plant cost data, and information concerning the nature of regulatory assets and liabilities being created or amortized during the period.33 Blank Forms No. 3-Q, available from FERC, further describe the required information. 34 Notes to Financial Statements. Entities filing Form No. 3-Q must include any relevant notes in their quarterly financial statements, just like those required in the
Electronic Filing of FERC Form 1 and Elimination of Certain Designated Schedules in FERC Form Nos. 1 and 1-F, Order No. 626, 99 FERC 61,179 (2002). Information, filing instructions and software for Form Nos. 1, 3-Q, 423, 714, 715, and E l e c t r i c Q u a r t e r l y R e p o r t s c a n b e f o u n d a t h t t p : / / w w w . f e r c . g o v / d o c s -filing/eforms.asp. Order No. 646, 106 FERC 61,113 at P 1. Small utilities, in limited cases, may seek a waiver from all or part of these filing requirements if they result in an undue burden. Id. at P 110.
33 34 32 31 30
Id. at PP 11, 18. See http://www.ferc.gov/docs-filing/eforms.asp.
47
annual reports. FERC has adopted the SEC s standard for interim reporting: i.e., reporting companies must include disclosures in the accompanying notes sufficient to ensure that the interim information is not misleading. Any material changes since the most recently completed year must be reported, including material changes to: accounting principles and practices; estimates inherent in the preparation of the financial statements; status of long-term contracts; capitalization including significant new borrowings or modifications of existing financing agreements; and changes resulting from business combinations or dispositions. However, affected entities may file abbreviated notes in their Form No. 3-Q. For example, notes that substantially duplicate the disclosures contained in the most recent FERC annual report may be omitted. On the other hand, any material events that are not reflected on the annual reports or that occur after the period reflected on the annual reports must be reported in the notes. Any material contingencies must be disclosed, even if a significant change since year end may not yet have occurred.35 Other Schedules for Quarterly Reports. In addition to the financial statements and relevant notes, affected entities must file a limited set of schedules updating equivalent Form No. 1 schedules. These include: Important Changes During the Quarter; Summary of Utility Plant and Accumulated Provisions for Depreciation; Amortization and Depletion, Plant in Service and Accumulated Provision for Depreciation By Function; Public Utility and Licensees Electric Revenues and Megawatt Hours; Depreciation, Depletion and Amortization Expenses of Utility Plant; Electric Production, Other Power and Transmission and Distribution Expenses; Customer Accounts, Service, Sales, Administrative and General Expenses; Other Regulatory Assets; Other Regulatory Liabilities; Transmission of Electricity For Others; Transmission of Electricity By Others; Monthly Peak Loads and Energy Output; and Monthly Transmission System Peak Load.36 Corporate Officer s Certification Statement. Appropriate corporate officers must sign and certify both Form No. 1 and Form No. 3-Q using certifications contained on the forms. Order No. 646 initially modified the Form No. 1 certification requirement to require a more stringent certification requirement than previously required for that form.37 However, the requirement to file the more stringent officer certifications for Form Nos. 1 and 1-F has been deferred indefinitely. 38 Respondents should thus continue to use the currently effective officer certification statements, as reflected on current Form Nos. 1 and 1-F.
35 36 37 38
Order No. 646, 106 FERC 61,113 at PP 35-40. See Form No. 3-Q (available at http://www.ferc.gov/docs-filing/eforms.asp). Order No. 646, 106 FERC 61,113 at P 100.
See Quarterly Financial Reporting and Revisions to the Annual Reports, 110 FERC 61,301 at P 7.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 2. Form No. 3-Q: How to File
Form No. 3-Q filing requirements are set forth in FERC s regulations.39 Form No. 3Q should be completed in accordance with the instructions provided in the regulations and on the form itself. For major electric utility companies, the reports must be filed within 60 days after each quarter.40 Non-major utilities, i.e., those companies that file FERC Form No. 1-F, must file Form No. 3-Q within 70 days of each quarter.41 Form No. 3-Q must be filed electronically using FERC s software.42 FERC s website contains a blank Form No. 3-Q, filing software, and instructions.43 C. FORM NO. 714 1. Requirement to File Form No. 714 Form No. 714 is an annual report that contains data from electric utility control and planning areas in the United States. The report is filed both by electric utilities or organizations (such as power pools, independent system operators, etc.) that operate control areas,44 and by electric utilities with annual peak demand greater than 200 MW. Information reported on Form No. 714 is not considered confidential. Form No. 714 data is collected pursuant to the FPA and the Commission s regulations. 45 Form No. 714 consists of four parts. Part I consists of identifying information of each utility in the control area. Part II consists of information about each generating plant in the control area, control area monthly capabilities at the time of monthly peak demand, control area net energy for load and peak demand by month, adjacent control area interconnections, control area scheduled and actual interchanges, and control area hourly system lambda. Part III consists of the prior year s summer and winter coincident peak demand, as well as electronic files containing (i) the prior year s hourly demand and (ii) forecast annual winter and summer peak and net energy for load for the next 10 years. Part IV consists of any notes necessary to explain the data in Parts I, II, and III. The control area must file Parts I, II, and IV. Those electric utilities that carry out the resource planning and demand forecasts for the planning area (and which have an annual
39 40 41 42 43 44
18 C.F.R. 260.300. Id. 260.300(b)(2)(vii). Id. 260.300(b)(3)(vii). Id. 260.300(b)(4). See http://www.ferc.gov/docs-filing/eforms.asp.
In each control area there is generally one electric utility charged with operating the control area and the associated automatic generation control equipment to ensure the security of the bulk power system. For example, the California ISO controls the transmission grid for California. It is these control area operators that must file Parts I, II, and IV of Form No. 714 as discussed below.
45
18 C.F.R. 141.51.
49
demand of 200 MW or more) must file Parts I, III, and IV. The resource planning utilities may include holding companies if the holding company actually performs the resource planning function; otherwise each operating company should file this data. Resource planning utilities may also include federal entities, municipal utilities, and generation and transmission cooperatives reporting on behalf of their members. If the resource planning and demand forecast information is reported to the respondent s regional reliability council, the council may provide the information on behalf of its members who are respondents (upon authorization from the utility). 2. Form No. 714: How to File Form No. 714 should be filed in hard copy (original plus three copies), along with CD-ROMs containing data. Filings must be made by June 1 of each year for the preceding calendar year.46 Detailed instructions are available on FERC s website, along with blank 47 forms and prior years data. D. FORM NO. 715 1. Requirement to File Form No. 715 Form No. 715, Annual Transmission Planning and Evaluation Report,is filed annually by any transmitting utility that operates network (not radial) transmission facilities at or above 100 kV. Form No. 715 is mandatory under sections 213(b), 307(a) and 311 of the FPA.48 For jointly owned facilities, only the operator of the facilities must complete Form No. 715. Transmission owning members of RTOs or ISOs who do not operate their own facilities are not required to file the form. Instead, in such cases, the RTO makes the required filing. Respondents must submit electronic copies of their base case power flow data. Alternatively, if the respondent participates in the development and use of regional power flow studies, it must either submit the regional or subregional base case power flow data, or designate any regional or subregional organization, or any other single entity to electronically submit the regional or subregional base case power flow data. In addition, respondents must submit (i) transmission system maps and single line diagrams; (ii) a detailed description of the transmission planning reliability criteria used to evaluate system performance; (iii) a detailed description of the respondent s transmission planning assessment practices; and (iv) a detailed evaluation of the respondent s anticipated system performance as measured against its stated reliability criteria using its stated assessment practices.
46 47 48
Id. See http://www.ferc.gov/docs-filing/eforms.asp. 16 U.S.C. 824l(b), 825f(a), & 825j.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 2. Form No. 715: How to File
Form No. 715 should be filed in hard copy (original plus two copies), or, under a trial program,49 may be filed electronically in PDF format, along with any CD-ROMs containing data. The deadline for filing is April 1 of each year for the preceding calendar year. If filed in hard copy, the applicant should include in the submission a complete electronic copy of the form and any associated data. Detailed filing instructions are available on FERC s 50 website. Information reported on Form No. 715 is considered Critical Energy Infrastructure Information ( CEII ) and is available to the public only under limited 51 circumstances. II. ELECTRIC UTILITIES, INDEPENDENT POWER PRODUCERS, AND POWER MARKETERS
A. ELECTRIC QUARTERLY REPORTS 1. EQR Filing Requirements In Order No. 2001,52 issued on April 25, 2002, FERC substantially revised the reporting and filing requirements for jurisdictional electric utility companies. All public utilities and power marketers must electronically file Electric Quarterly Reports ( EQRs ) at the Commission.53 EQRs are electronic data files that summarize the contractual terms and conditions contained in FERC-jurisdictional power sales and transmission service agreements, including short-term and long-term market-based power sales, cost-based power sales, and transmission service agreements during the most recent calendar quarter. Order No. 2001 modified the prior FPA filing requirements in several significant ways. Previously, utilities met their FPA filing burden by filing cost-based power sales agreements, transmission service agreements, and other service agreements with the Commission prior to the commencement of service. If the utility had approved tariff agreements and associated standard forms of agreements on file with the Commission, the utility could file the individual service agreement within thirty days after service to that customer. For short-term power sales transactions of one year or less (pursuant to marketbased rate tariffs), the Commission required public utilities (not power marketers) to submit an umbrella service agreement for each customer and then submit paper copies of Quarterly Transaction Reports summarizing the numerous transactions under those agreements. This was done in lieu of filing individual service agreements for each transaction. For power
49 50 51 52
See http://www.ferc.gov/docs-filing/eforms/form-715/tri-alt-fil-meth.pdf. See http://www.ferc.gov/docs-filing/eforms/form-715/instructions.asp. See 18 C.F.R. 141.300(d).
Revised Public Utility Filing Requirements, O r d e r N o . 2 0 0 1 , 9 9 F E R C 6 1 , 1 0 7( O r d e r N o . 2 0 0 1 ) , r e h g d e n i e d , Order No. 2001-A, 100 FERC 61,074, reconsideration denied, Order No. 2001-B, 100 FERC 61,342 (2002). In very limited cases, small entities may seek waivers of all or part of these filing requirements. Order No. 2001, 99 FERC 61,107 at P 362; B r i d g e r V a l l e yE l e c . A s s n , I n c ., 101 FERC 61,146 (2002).
53
51
marketers selling at market-based rates, the Commission did not require the filing of any service agreements (short or long-term), but only required power marketers to file Quarterly Transaction Reports covering both their short-term and long-term market-based sales. The EQRs replaced many of the requirements under the Commission s prior rules. The significant changes in the Order No. 2001 filing requirements are as follows:54 Utilities with standard forms of agreements in their tariffs. Utilities that have standard agreements in their FERC-approved transmission, cost-based power sales tariffs, or tariffs for other generally applicable services no longer need to file those agreements when they enter into transactions that conform to those standard agreements. Instead, the FPA filing requirements will be met simply by having those standard agreements on file at FERC and by filing EQRs.55 Utilities that do not have standard service agreements approved as part of their tariffs may file such agreements for Commission approval. Non-conforming agreements. Utilities may not always wish to enter into agreements that conform precisely to the standard agreements on file with FERC. Utilities seeking to enter into non-conforming agreements for transmission, costbased power sales, and other generally applicable services, including agreements with individualized terms and conditions or unexecuted agreements for any service, must file such agreements with the Commission for prior approval. Power marketers and utilities with market-based rate authority. Affiliated and unaffiliated power marketers, and utilities with market-based rate authority,56 must file data relating to their market-based power sales in their EQRs. Individual market-based sales agreements that are entered into under the seller s FERC-approved market-based rate tariff need not be separately filed with the Commission. Companies with market-based rates must file EQRs regardless of the number of transactions that occur in a quarter, even during periods when the company makes no sales. o Exception: Contracts with Affiliates. FERC generally requires prior approval of all power sales between a utility with a franchised service territory and any affiliates with market-based rate authority. These
In the Order No. 2001 Notice of Proposed Rulemaking, the Commission initially p r o p o s e dt oa d o p t f i l i n gr e q u i r e m e n t s s i m i l a r t ot h e I n d e xo f C u s t o m e r s r e q u i r e do f n a t u r a l g a s c o m p a n i e s .T h e C o m m i s s i o nu l t i m a t e l ya d o p t e da na p p r o a c hs i m i l a r t ot h e I n d e xo f C u s t o m e r s , b u t n a m e dt h e d a t a f i l e s E l e c t r i c Q u a r t e r l y R e p o r t s . I t s h o u l da l s ob e n o t e dt h a t i n t h e f i n a l o r d e r (Order No. 2001), FERC dropped its earlier suggestion that companies maintain EQRs on their own websites.
55 56 54
See Order No. 2001, 99 FERC 61,107 at P 18.
Order No. 2001 did not change the requirement that companies seeking to sell power at market-based rates must first have a FERC-approved market-based rate tariff on file with FERC. Chapter 7 of this Handbook discusses the process for obtaining market-based rate authorization.
52
ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK agreements must be filed for Commission approval prior to service. However, affiliated power marketers may seek a waiver of this restriction in certain cases such as in conjunction with strictly monitored competitive auctions that meet the Commission s standards57 or where the utility affiliate has no captive wholesale customers and where retail ratepayers are protected by a rate freeze or the availability of retail choice.58 2. New Items Required to be Filed
Order No. 2001 clarified that disaggregated book out transactions must be reported in the EQRs.59 Previously, FERC did not require utilities or power marketers to report book outs, and thus the need to file book outs in the Quarterly Transaction Reports was unclear. FERC also previously did not require utilities or power marketers to report actual rates in certain cost-based rateson file that do not state the actual rate charged (such as split-the-savings rates, discounts below a maximum rate, and formula rates). The new rules require utilities to report the actual rate being charged under such agreements in their EQRs. 3. How to File EQRs; Penalties for Non-Compliance EQRs must be filed electronically using software available on FERC s website.60 FERC s website also offers templates specifying the type of data to be filed. The Commission does not allow confidential filings because it does not consider the information in EQRs to be commercially sensitive. The filing software is revised from time to time. 61 FERC has issued an instruction manual as well as additional instructions for completing EQRs.62 All EQRs and, if necessary, requests for extensions of time, should be filed in Docket No. ER02-2001.
See, e.g., Public Serv. Elec. & Gas Co., 111 FERC 61,152 (2005) (granting approval to make affiliate sales and granting requested waivers in conjunction with affiliate sales resulting from the already established statewide competitive auction process in New Jersey). See, e.g., Duquesne Power, L.P., 108 FERC 61,160, at P 39 (2004). See Chapter 7 for a discussion of affiliate sales requirements. Power marketer transactions often involve the matching of sale and purchase obligations w i t h o u t t h e s c h e d u l i n go r d e l i v e r yo f e l e c t r i c e n e r g y .S u c h t r a n s a c t i o n s a r e c o m m o n l yc a l l e d b o o k o u t s . Revised Public Utility Filing Requirements, Order No. 2001-C, 101 FERC 61,314, at P 9 ( 2 0 0 2 ) ( O r d e r N o . 2 0 0 1 -C ) . T h e website is found at: http://www.ferc.gov/docs-filing/egr.asp. See, e.g., Revised Public Utility Filing Requirements, Order No. 2001-E, 105 FERC 6 1 , 3 5 2( 2 0 0 3 ) ( O r d e r N o . 2 0 0 1 -E ) .F E R Ca l s oh a s h e l da n dc o n t i n u e s t oh o l dw o r k s h o p s a n d meetings addressing EQRs. Notices of such meetings are published in Docket Nos. RM01-8 and ER02-2001. See Revised Public Utility Filing Requirements, 99 FERC 61,238 (2002) (interim instruction manual); Order No. 2001-C, 101 FERC 61,314 (electronic filing using FERC software);
62 61 60 59 58 57
53
The deadline for filing EQRs is 30 days after each calendar quarter. The penalties for failure to file are severe. If a public utility fails to file an EQR or request an extension, or fails to report a transaction in a report, the utility may forfeit its market-based rate authority and may be required to file a new application for market-based rate authority if it wishes to resume making sales at market-based rates.63 In addition, some parties have argued that improper, incorrect, or incomplete filings could impose liability under Lockyer v. FERC.64 In that case, the petitioners argued that a company s failure to file adequate data as required in FERC quarterly reports was a violation of the underlying market-based tariff because, as FERC itself had already held in its decision at the agency level, sufficiently detailed data were necessary so that the [seller s] rates will 65 be on file as required by section 205(c) of the FPA. Under this theory, where data required to be filed under a market-based rate tariff is so egregiously insufficient, there is no 66 filed tariff in place at all. The Ninth Circuit held that FERC has the authority to order retroactive refunds back to the first violation of the filing requirement, though that holding is pending rehearing en banc. If this view of the Lockyer decision is sustained, FERC may be able to impose refunds further back than is normally allowed under section 206 of the FPA, which provides for a refund effective date of 60 days after the initiation of the section 206 complaint.67 Though there are a number of arguments running contrary to that view, Lockyer
Notice on Filing Guidance, Docket No. RM01-8 (Oct. 21, 2002); Notice Providing Detail On Electric Quarterly Reports Software Availability, Docket No. RM01-8 (Dec. 20, 2002); Errata Notice, Docket No. RM01-8 (Jan. 7, 2003); Order No. 2001-E, 105 FERC 61,352 (standard formats to be used for certain fields); Revised Public Utility Filing Requirements, Order Providing For Future Changes to EQRs, 106 FERC 61,281 (2004). Order No. 2001, 99 FERC 61,107 at P 222. Generally, market-based rate authority will be revoked after a notice and the failure of a party to respond to Commission communications. See, e.g., Electric Quarterly Reports, Intent to Withdraw Market-Based Rate Authority, 104 FERC 61,139 (2003); Electric Quarterly Reports, Order on Market Based Rates, 105 FERC 61,219 (2003); Notice of the Revocation of Market-Based Rate Tariffs, Docket No. ER02-2001-003 (Sept. 20, 2004). 383 F.3d 1006 (9th Cir. 2004). Lockyer i n v o l v e dt h eS t a t e o f C a l i f o r n i a s a p p e a l o f a FERC decision in which FERC declined to order refunds against sellers of electricity involved in the C a l i f o r n i ae l e c t r i c i t yc r i s e so f2 0 0 0a n d2 0 0 1 .C a l i f o r n i a ss e c t i o n2 0 6c o m p l a i n t a l l e g e dt h a t F E R C s m a r k e t -based rate and quarterly-filing requirements were inconsistent with the FPA, and that transaction-specific data instead of aggregated data should have been filed in the Quarterly Reports. FERC agreed that transaction-specific data should have been filed, but it viewed those filing violations as compliance issues for which re-filing of the quarterly reports was a sufficient remedy. FERC declined to order refunds, noting that its refund authority under the FPA was limited to a r e f u n d e f f e c t i v e d a t e o f 6 0 d a y s a f t e r t h e f i l i n g o f a s e c t i o n 2 0 6 c o m p l a i n t .
64 65 66 67 63
Id. at 1014 (citing Enron Power Mktg., 65 FERC 61,305 (1993)). Id. at 1015-16. 16 U.S.C. 824e(b).
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at a minimum underscores the importance of full compliance with the quarterly reporting obligations.68 B. REPORTING OBLIGATIONS OF ENTITIES WITH MARKET-BASED RATE AUTHORITY 1. Changes in Status As a condition in orders granting market-based rate authority, FERC traditionally had required utilities with market-based rate authority to file updated market power analyses every three years ( triennial review ). FERC also required power marketers to promptly notify the Commission of any changes in status affecting their market power. FERC later allowed market-based rate holders to choose between notifying FERC promptly of changes in status, notifying FERC of changes in status in three-year updates, or reporting changes in status in their next triennial review. In Order No. 652, FERC clarified and standardized the reporting obligations of market-based rate holders.69 That order requires all holders of market-based rate authority to report changes in status within 30 days after such changes in status. Order No. 652 also amended the Commission s regulations to establish guidelines concerning the types of changes in status that must be, or need not be, reported.70 The baseline for determining whether a change in status filing is required is whether the event would have been reportable in an initial application for market-based rate authority.71 Such changes include, but are not limited to, when a market-based rate applicant: acquires an ownership interest in or controlof generation or transmission 72 facilities other than those identified in the application for market-based rates; or
A sn o t e da b o v e ,E P A c t2 0 0 5g r e a t l ye x p a n d e dF E R C sa u t h o r i t yt oi m p o s ec i v i l penalties for violations of any provision of Part II of the FPA, including any rules or orders issued under those FPA provisions. EPAct 2005 1284(b), 119 Stat. at 980 (amending 16 U.S.C. 825o-1).
68
Reporting Requirement for Change in Status for Public Utilities with Market-Based Rate Authority, Order No. 652, 110 FERC 6 1 , 0 9 7 ( O r d e r N o . 6 5 2 ) , o r d e r o n r e h g , Order No. 652-A, 111 FERC 61,413 (2005). FERC concluded, for example, that increases in ownership or control of generation of less than 100 MW need not be immediately reported. Order No. 652, 110 FERC 61,097 at P 68. A t am i n i m u m , as e l l e r m u s t s u b m i t a n a r r a t i v ee x p l a i n i n gw h e t h e r ( a n d , i f s o , h o w ) [the] change in status reflects a departure from the characteristics relied upon by the Commission in originally granting the seller market-based rate auth o r i t y . Id. at P 93.
71 70
69
T h e t e r m c o n t r o l r e f e r s g e n e r a l l yt oa r r a n g e m e n t s , c o n t r a c t u a l o r o t h e r w i s e , t h a t g r a n t entities decisional or other authority over generation or transmission facilities effectively akin to ownership; however, FERC declined to provide a list of all events constituting control of an asset. Id. at P 47. In terms of duration of the controlled asset, FERC specified that long-term contracts with a duration of a year or more must be reported. Id. at P 48.
72
55
becomes affiliated with any entity which owns or controls generation or transmission facilities other than those identified in the application for marketbased rates; or becomes affiliated with any entity that has a franchised service area.73 Applicants filing a notice of a change in status are not required to file a full-blown updated market power analysis, such as that required in the triennial review. 74 However, an entity may provide such an analysis if it chooses, and FERC may require such a filing if it is not provided initially. Notices of changes in status should be submitted separately from triennial market-power updates, and should not be combined with any other reports or filings. Change in status filings should be made in the docket(s) originally granting market-based rate authority to the applicant. Such filings are treated as compliance filings and hence are not subject to the 60-day prior notice requirement in FPA section 205(d).75 2. Triennial Review As discussed in Chapter 7, all entities holding market-based rate authority must submit a new market power analysis every three years. Triennial reviews require a full analysis of the applicant s market power, much like the analysis required when seeking market-based rate authority for the first time. The details, though evolving, are addressed in Chapter 7. 3. Other Reporting Obligations Relating to Market-Based Rates Sellers with market-based rate authority should also be aware of any changes to their market-based rate tariffs that may impose additional obligations to file reports to FERC. For example, as a result of the energy crises in California in 2000 and 2001, the Commission issued an order requiring market-based rate holders to revise their market-based rate tariffs to incorporate, by the earliest of any amendment to their market-based rate tariff or their next triennial review, six Market Behavior Rulesprescribed by FERC. 76 The six behavioral
Id. at P 18. It should be noted that if an entity with market-based rates plans to merge with another entity, the merger or consolidation likely will require FERC authorization under section 203 of the FPA. See Chapter 5 of this Handbook for a discussion of FPA section 203.
74 75 76 73
Id. at P 95. 16 U.S.C. 824d(d).
Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Amending Market-Based Rate Tariffs and Authorizations, 105 FERC 61,218 ( 2 0 0 3 ) ( Ma r k e t B e h a v i o r R u l e s O r d e r ) , order on r e h g , 107 FERC 61,175 (2004). FERC recently proposed, in Docket No. RM06-3, new regulations that expressly prohibit manipulation of the energy markets. Prohibition of Energy Market Manipulation, 113 FERC 61,067 (2005) (proposing to add section 47.1 t o F E R C s r u l e s ( 1 8 C . F . R . 4 7 . 1 ) ) . F E R Ci s a l s o c o n s i d e r i n g , i n D o c k e t N o . E L 0 6 -16, whether it needs to continue the Market Behavior Rules in view of the increased authority over market manipulation provided in EPAct 2005 and in light of the Docket No. RM06-3 rulemaking. Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Proposing Revisions to Market-Based Rate Tariffs and Authorizations, 113 FERC 61,190 (2005).
56
standards: (i) require sellers to operate units in accordance with the power market into which they are selling; (ii) prohibit all forms of market manipulation; (iii) require sellers to provide complete, accurate and factual information to FERC, any ISO or RTO, among others; (iv) require that accurate information also be provided to publishers of electricity or natural gas price indices; (v) require sellers to retain price-related data for three years; and (vi) prohibit sellers from violating or colluding with another party so as to violate their code of conduct or Order No. 889 Standards of Conduct.77 Market Behavior Rule 4, relating to reports to publishers of price indices, creates an obligation to notify FERC, within 15 days of a company s adopting Rule 4, whether the company reports transactions to publishers of electricity or natural gas price indices.78 Recently, FERC clarified that any changes to a company s practice with respect to index reporting also must be reported within 15 days.79 All notices required under this rule should be filed under Docket No. EL01-118. III. OTHER REPORTING REQUIREMENTS In addition to the reporting obligations discussed above, the FPA and FERC s rules require jurisdictional utilities to file a host of other forms. Some of these reporting obligations are required periodically, while others may be triggered only upon certain events or activities. Utilities should thus determine whether any such filing requirements apply to them, what the deadlines are, and whether FERC has amended or clarified any applicable filing requirement. A. FERC FORM NO. 423 Every FERC-jurisdictional electric power producer that owns or operates certain electric generating plants with rated capacities of 50 megawatts or greater must file Form No. 423 for each plant.80 Form No. 423 is a monthly report stating the cost and quality of fuel delivered to each generating plant. Specifically, Form No. 423 contains data on price, quantity, quality, source location (for coal), supplier, and contract term relating to fossil fuels delivered to steam turbine generating plants and combined-cycle gas turbines (with associated steam turbines) having a generating capacity of 50 megawatts or greater. Fuel delivered for use in gas turbine or internal combustion units that are not associated with a combined-cycle operation are not required to be reported.
The Market Behavior Rules and the recent developments are discussed in more detail in Chapter 9 of this Handbook. Market Behavior Rules Order, 105 FERC 61,218 at App. A. FERC proposed that any seller found to have engaged in the behavior prohibited by its Market Behavior Rules may be subject to a disgorgement remedy and any other appropriate non-monetary remedies such as revocation of s e l l e r s m a r k e t -based rate authority. Id.
78 79 77
Id.
Price Discovery in Natural Gas and Electricity Markets, Order Further Clarifying Policy Statement on Natural Gas and Electric Price Indices, 112 FERC 61,040 (2005).
80
See 18 C.F.R. 141.61.
57
FERC Form No. 423 was first mandated by the FPC in 1972 when it issued Order No. 453, adding section 141.61 to its regulations. In 1974, in Order No. 512, the FPC extended the reporting requirements to include fuel received at gas turbine and internal combustion engine generating plants.82 Form No. 423 was further revised by Order No. 264 in 1982 to reduce reporting requirements and exempt plants with capacities under 50 megawatts.83
81
Affected entities should file Form No. 423 no later than 45 days after the end of the reporting month. The form must be filed electronically.84 FERC s website contains a blank form, instructions and electronic submission software that allows electronic filing of the data.85 FERC does not consider the data to be confidential; however, it may take up to three months for FERC to process the data, perform error checks, and make its monthly database publicly available. The Commission collects Form No. 423 information pursuant to sections 205 and 206 of the FPA.86 FERC has granted waivers of the filing requirements to certain entities that sell all of their power at market-based rates. However, FERC has rejected waiver requests if any customers are subject to cost-based rates, including through the use of fuel-adjustment clauses.87 It should be noted that certain non-utility generators that do not need to file Form No. 423 may be required to file substantially the same form at the EIA on Form EIA-423. Under the EIA s filing requirements, owners or operators of a non-utility electricity generating plants or combined heat and power plants that do not file FERC Form No. 423 must file Form EIA-423 if the plant s total fossil-fueled nameplate generating capacity is 50 88 megawatts or more. This includes plants that have tolling agreements, in which cases all
Monthly Report of Cost and Quality of Fuels for Steam-Electric Plant, Order No. 453, 47 F.P.C. 1469 (1972). Monthly Report of Cost and Quality of Fuels for Steam-Electric Plant, Order No. 512, 52 F.P.C. 745 (1974). Revision of Monthly Report of Cost and Quality of Fuels for Electric Plant, Order No. 264, FERC Stats. & Regs., Regulations Preambles 1982-1985 30,402 (1982). 18 C.F.R. 141.61(b); see also Electronic Filing of FERC Form No. 423, Order No. 622, 97 FERC 61,318 (2001).
85 86 84 83 82 81
See http://www.ferc.gov/docs-filing/eforms.asp.
FERC has relied on Form No. 423, for example, to assess competition aspects in a merger application. See NorAm Energy Servs., Inc., 80 FERC 61,120 (1997). Experts and FERC Trial Staff use Form No. 423 data as the basis for studies conducted in preparation for electric utility rate cases and to compare fuel costs for utilities. See Indiana & Michigan Municipal Distributors A s s n and City of Auburn, Indiana v. Indiana Michigan Power Co. , 62 FERC 61,189, at 62,240 n.116 (1993) (noting Trial Staff relied on Form No. 423 data). See, e.g., Atlantic City Elec. Co. & Delmarva Power & Light Co., Letter Order, Docket No. ER01-1158-000 (Mar. 29, 2001). See http://www.eia.doe.gov/cneaf/electricity/forms/eia423/eia423instr.pdf. The EIA has authority to collect data from energy companies. See 15 U.S.C. 772(b).
88 87
58
necessary data must be obtained from the fuel supplier. If the fuel supplier does not provide the data to the owner or operator, the fuel supplier will be responsible for filing the form. Due dates are 45 days after the end of the reporting month. Unlike at FERC, Form EIA-423 data reflecting the Delivered Fuel Cost-Plant Purchase Price is kept confidential, although the remainder of the data are not confidential. Filing information and electronic filing are available at the EIA website.89 B. FERC REPORTING REQUIREMENT NO. 523: APPLICATIONS FOR AUTHORIZATION ISSUANCE OF SECURITIES OR THE ASSUMPTION OF LIABILITIES
FOR THE
Under FPA section 204,90 prior FERC approval is needed before any public utility or licensee (with certain exemptions) may issue securities or assume obligations or liabilities (e.g., as guarantor, endorser, surety, or otherwise) with respect to any securities of another person. FERC s regulations describe the content and format of such applications. 91 Once FERC has authorized the issuance of securities or assumption of liabilities, utilities are then required to notify FERC, in FERC Reporting Requirement No. 523 ( FERC-523 ), within 30 92 days after any sales of securities or assumption of liabilities. The specific format of FERC523 reports and the required contents are detailed in FERC s regulations. 93 Furthermore, pursuant to a recent FERC order, all FERC-523 reports now must be made electronically. 94 C. FORM NO. 561: INTERLOCKING DIRECTORATES Section 305(c)(1) of the FPA95 creates a statutory obligation requiring all individuals holding interlocking directorate positions between public utilities and certain other entities during any part of the calendar year to file an annual report of interlocking positions in Form No. 561.96 Persons who must file these forms include those subject to section 305(b) of the FPA,97 which provides that no person may hold a position as officer or director of (1) two or more utilities, (2) a utility and any bank or other financial institution allowed by law to issue securities of a utility (under certain circumstances), or (3) a utility and any company supplying electrical equipment to a utility, without prior approval from the Commission.98
89 90
See http://www.eia.doe.gov/cneaf/electricity/page/forms.html.
16 U.S.C. 824c. The requirements of section 204 are discussed in greater detail in Chapter 6 of this Handbook. 18 C.F.R. Part 34. Interlocking directorate requirements are discussed in more detail in Chapter 12 of this Handbook.
92 93 94 91
Id. 34.10. Id. 131.43, 131.50.
Electronic Filing of the Application for Authorization for the Issuance of Securities or the Assumption of Liabilities, Order No. 657, 111 FERC 61,282 (2005).
95 96 97 98
16 U.S.C. 825d(c). See 18 C.F.R 46.4 to 46.6. 16 U.S.C. 825d(b)(1). See id. 825(b)(2); 18 C.F.R. 46.5.
59
Form No. 561 annual reports must be submitted on or before April 30 of each year for the preceding calendar year. The forms may be submitted in hard copy. A representative form and instructions are provided in FERC s regulations. 99 Instructions and blank forms are 100 also available on FERC s website. Although not affecting the annual report, FERC recently clarified and amended its regulations regarding prior FERC approval of interlocking directorates.101 The new rules are addressed in Chapter 12. D. FORM NO. 566: TOP 20 PURCHASERS LIST Pursuant to FERC s regulations, every public utility must file a list identifying the name and business addresses of its top twenty largest purchasers of electric energy (as measured in kilowatt hours sold), for purposes other than resale, during the three preceding calendar years.102 If no sales were made other than sales for resale, utilities may simply inform FERC that no such sales were made. Lists must be filed on or before January 31 of each year.103 Utilities also must notify each purchaser, by January 31, that it has been identified on the utility s list.104 If any information is estimated, revisions must be provided by March 1.105 The rules do not specify any specific format for such lists. However, samples may be obtained by searching FERC s website for previously filed forms. These lists generally are submitted in hard copy format under a cover letter and do not bear a docket number. E. FORM NO. 580: INTERROGATORY ON FUEL AND ENERGY PURCHASE PRACTICES All jurisdictional utilities having at least one steam-electric generating facility of 50 MW or greater capacity, or having an ownership interest of 50 MW or greater capacity in a jointly-owned steam-electric station, must complete and file Form No. 580 with FERC every two years. Form No. 580 consists of questions ( interrogatories ) that elicit information on the cost, quantity, quality, and origin of coal, oil and gas purchased under contract by such utilities owning such generating plants during the preceding two years.
99 100 101
18 C.F.R. 131.31. See http://www.ferc.gov/docs-filing/hard-fil.asp.
See Commission Authorization to Hold Interlocking Positions, Order No. 664, 112 FERC 61,298 (2005) ( Order No. 664 ). See also Chapter 12, providing a detailed discussion of interlocking directorate requirements.
102 103 104 105
18 C.F.R. 46.3. Id. 46.3(a). Id. 46.3(d). Id. 46.3(e).
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FERC began collecting Form No. 580 data in 1979, pursuant to an investigation ordered in Docket No. IN79 6, to meet its obligations under section 205 of the FPA.106 Specifically, the data is designed to meet FERC s obligation under that section to review the practices under any automatic adjustment clauses of such utility to insure efficient use of resources (including economical purchase and use of fuel and electric energy) under such 107 clauses. FERC uses this information to, among other things, assess fuel costs in individual rate filings to determine whether such costs are just and reasonable, to review fuel costs passed through automatic fuel adjustment clauses, and, if necessary, to initiate action pursuant to FPA section 205(f)(3). The information in Form No. 580 is narrower than that required in Form No. 423. Form No. 580 should be filed under Docket No. IN79 6. Current forms and instructions can be obtained from FERC s website.108 FERC s instructions currently require Form No. 580 to be filed in hard copy (an original and three copies), along with one electronic copy on diskette. The last collection was due on October 15, 2004, for calendar years 2002 and 2003. Affected entities should consult FERC s website for the due date of the 2006 form and any additional filing requirements. F. FERC REPORTING REQUIREMENT NO. 582: ANNUAL CHARGES REPORT As part of FERC s collection of annual charges for administering its electric regulatory program, FERC requires every public utility that provides interstate transmission service to report, in Reporting Requirement No. 582 ( FERC-582 ), the total megawatt-hours of transmission service provided each year under its tariff.109 The total amount of transmission service is measured by the total megawatt-hours of unbundled transmission plus the amount of transmission service in bundled wholesale power sales (i.e., transmission service that is not separately reported as unbundled transmission).110 Utilities that do not provide such transmission service are not required to file FERC-582. FERC uses FERC-582 reports to assess annual charges to utilities based on the volume of electricity transmitted by those utilities.111 The utility that pays the annual charge is the utility that has a tariff or rate schedule on file with FERC. Thus, if a utility has joined an ISO or RTO and does not otherwise provide transmission service pursuant to its own tariff, the ISO or RTO public utility will be responsible for paying annual charges.112
106 107 108 109 110 111
16 U.S.C. 824d(f). Id. http://www.ferc.gov/docs-filing/hard-fil.asp. 18 C.F.R. 382.201(c). Id.
See Revision of Annual Charges Assessed to Public Utilities, Order No. 641, 93 FERC 6 1 , 0 8 3 ( 2 0 0 0 ) ( O r d e r N o . 6 4 1 ) ( a d o p t i n g t h e c u r r e n t r e g u l a t i o n s i n 1 8 C . F . R . 3 8 2 . 2 0 1 ( c ) ) , order o n r e h g , Order No. 641-A, 94 FERC 61,290 (2001).
112
See id.
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Utilities that are members of an ISO or RTO should thus coordinate with the ISO or RTO with respect to which entity must report which transactions.113 FERC has recognized that a utility may arrange for an agent to act on its behalf (for example, in scheduling or billing for transmission service).114 In such cases, the utility is still expected to report the transmission service because it, not the agent, has the tariff on file.115 Utilities thus should maintain information regarding their annual transmission service in sufficient detail to comply with this reporting obligation. FERC-582 reports must be submitted, under oath, by April 30 of each year.116 Reports may be e-filed pursuant to FERC s e-filing program. G. REPORTING OF ELECTRIC ENERGY SHORTAGES CONTINGENCY PLANS Pursuant to its responsibility under section 202(g) of the FPA, 117 FERC requires each public utility to report promptly to FERC and appropriate state regulatory authorities any anticipated shortage of electric energy or capacity which that affect the public utility s ability to serve its wholesale customers.118 Among other things, such a report must describe the nature and projected duration of the anticipated shortage, include a list of firm wholesale customers likely to be affected by the shortage, and include procedures for accommodating the shortage and a contact person at the public utility. FERC recently issued an order requiring that these reports be submitted in a single electronic filing.119 FERC stressed the immediacy inherent in such filings in requiring electronic filing. The filing should be made through FERC Division of Reliability s pager system at emergency@ferc.gov. H. ORDER NOS. 580 AND 658 NUCLEAR DECOMMISSIONING TRUST FUND In Order No. 580, FERC established regulations governing nuclear plant decommissioning trust funds subject to FERC jurisdiction and any investments in those funds.120 To the extent that a utility has such a fund, the regulations set forth how such funds
Order No. 641 provides additional scenarios with respect to allocating transmission service among ISOs, RTOs and utilities for purposes of FERC-582.
114 115 116 117 118 119 113
See Order No. 641, 93 FERC 61,083 at n.53. Id. 18 C.F.R. 382.201(c). 16 U.S.C. 824a(g). 18 C.F.R. 294.101.
Electronic Reporting of Shortages and Anticipated Shortages of Electric Energy and Capacity, Order No. 659, 111 FERC 61,286 (2005). Nuclear Plant Decommissioning Trust Fund Guidelines, Order No. 580, FERC Stats. & Regs., Regs. Preambles 1991-1996 31,023 (1995), o r d e r o n r e h g , Order No. 580-A, FERC Stats. & Regs., Regs. Preambles 1996-2000 31,055 (1997).
120
62
may be established, organized, and operated.121 The regulations further require utilities to submit to FERC, by March 31 of each year, copies of the financial reports furnished by the fund s trustee to the utility, showing the fund s assets and liabilities and any activity of the fund during the period (including amounts deposited in the fund, purchases and sales of investments, gains and losses from investment activity, disbursements from the fund for decommissioning activity, and payment of fund expenses, including taxes).122 These financial reports are typically filed in hard copy (an original and three copies) under a cover letter in Docket No. RM94-14. In a subsequent order, Order No. 658, FERC modified the trust fund reporting obligation to remove the requirement that the annual financial report must show all purchases and sales of investments in each fund.123 Instead, utilities need only provide a summary of the purchases and sales of fund investments. All other reporting requirements remain the same. While FERC still requires utilities to keep detailed records of fund transactions, this change can be expected to reduce the amount of data required to be filed with FERC on an annual basis. IV. COMPLIANCE CONSIDERATIONS Given the broad and disparate reporting obligations discussed in this chapter, it is little wonder that a number of companies have adopted, at least in some cases, decentralized approaches to fulfilling their FERC reporting obligations. For example, companies may assign the full reporting responsibility, including both information gathering and the final submission of the report, to discrete business units having expertise over the issue. In light of the recent increases in FERC penalty authority in EPAct 2005 and other potential penalties such as refund obligations and loss of market-based rate authority, companies should consider establishing a central clearing house, such as a compliance team, for assessing, assigning, and monitoring the company s reporting obligations. A first step could include a company-wide inventory of the reports currently filed by the company. This inventory might include a list of personnel or departments responsible for both information gathering and submission of the reports, the due dates of the reports, any procedures that have been adopted to ensure that reports are timely filed, and other such information. The compliance team could review the reports to ensure that they are complete and also to ensure that all required reports are being filed. Going forward, the compliance team may wish to create a mechanism for marking the progress of required filings, such as through direct communications to responsible personnel or through an interactive database or checklist. The compliance team also may make recommendations to ensure that employees and departments have the resources necessary to complete reports assigned to them. While we expect that companies will continue to delegate certain reporting functions to individual employees or departments, the existence of a centralized compliance team will help ensure that all the required reports are filed on a timely and complete basis.
121 122 123
18 C.F.R. 35.32 to 33.33. Id. 35.33(d).
Modification of Nuclear Plant Decommissioning Trust Fund Guidelines, Order No. 658, 111 FERC 61,279 (2005).
Chapter 5 Section 203 of the Federal Power Act: Mergers, Acquisitions and Reorganizations
KATHLEEN L. BARRN MARY MARGARET FARREN
OVERVIEW Section 203 of the Federal Power Act ( FPA )1 is one of the shortest provisions in the Act, but as applied it has a wide reach across an extensive number of activities, transactions, and reorganizations. The Federal Energy Regulatory Commission ( FERC or Commission ) interprets section 203 broadly, and views its section 203 authority as central to its responsibility to ensure the maintenance of adequate service, competitive wholesale markets and just and reasonable rates. FPA section 203 governs not only divestitures and mergers, but also changes in control that result from leases, internal reorganizations, and potentially other forms of contractual relationships. Section 203 was amended significantly in the recently-enacted Energy Policy Act of 2005 ( EPAct 2005 ).2 This chapter reflects the 3 law as revised by EPAct 2005. The purpose of this chapter is to identify the transactions that require approval under FPA section 203. In addition, a short summary of the standards applied by the Commission when deciding whether or not to grant section 203 approval is provided.4 In EPAct 2005, the Commission was given civil penalty authority to punish violations of the FPA, including section 203, in an amount up to $1 million per day per violation.5 Prior to the passage of EPAct 2005, the Commission noted in several orders that while it did
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Ms. Barrn joined Skadden in
1995. Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 1997, Ms. Farren served as an associate in the law firm of Steptoe & Johnson LLP.
1 2 3
16 U.S.C. 792 et seq. (2005). Pub. L. No. 109-58, 119 Stat. 594 (2005).
Where appropriate, this chapter also reflects the Commission s October 23, 2005 Notice of Proposed Rulemaking relating to the new section 203 adopted in EPAct 2005. Transactions Subject to FPA Section 203, Notice of Proposed Rulemaking, 113 FERC 61,006 (2005) ( 203 NOPR ). The EPAct 2005 revisions to FPA section 203 take effect February 8, 2006. A complete discussion of these standards (e.g., the generation market power analysis required under Appendix A of the Merger Policy Statement) is beyond the scope of this Compliance Handbook.
5 4
See Chapter 3, Penalty Authority, for a discussion of the Commission s penalty authority.
64
not have civil penalty authority . . . the Applicants failure to obtain prior Commission approval for [a section 203 jurisdictional] transaction is the type of violation for which the 6 imposition of a penalty would be appropriate. Such past statements suggest that the Commission is likely to use its new civil penalty authority to encourage future compliance with section 203. The failure to seek prior approval also can, under certain circumstances, constitute a default or breach of a transaction agreement, potentially giving the counterparty a right of action at law or in equity. Finally, failure to receive approval of a particular transaction, such as a jurisdictional asset acquisition, can impair a company s ability to make certain representations and warranties in a subsequent transaction concerning the same asset. I. SPECIFIC COMPLIANCE REQUIREMENTS
A. TYPES OF TRANSACTIONS COVERED BY SECTION 203 FPA section 203 applies to several different types of transactions. Jurisdictional Facilities. Prior Commission approval is required for a public utility7 to sell, lease, or otherwise dispose of the whole of its facilities subject to the jurisdiction of the Commission, or any part thereof of a value in excess of 8 $10,000,000. The Commission has interpreted this to apply to direct as well as indirect changes in control over jurisdictional facilities, such as through internal corporate reorganizations. Mergers. Prior Commission approval is required for a public utility to merge or consolidate, directly or indirectly, [its] facilities or any part thereof with those of 9 any other person, by any means whatsoever. Securities. Prior Commission approval is required for a public utility to purchase or acquire any security with a value in excess of $10,000,000 of any other public 10 utility. Generating Facilities. Prior Commission approval is required for a public utility to purchase, lease or otherwise acquire an existing generation facility valued at
Puget Sound Energy, Inc., 110 FERC 61,161 at P 16 (2005); see also Mesquite Investors L.L.C., 111 FERC 61,162, at P 19 (2005); Northern Iowa Windpower II LLC, 110 FERC 61,059, at P 13 (2005). Under FPA section 201(e), a public utility . . . means any person who owns or operates facilities subject to the jurisdiction of the Commission. 16 U.S.C. 824(e). Facilities subject to the Commission s jurisdiction are described below.
7 8 9 10
Id. 824b(a)(1)(A). Id. 824b(a)(1)(B). Id. 824b(a)(1)(C).
SECTION 203 OF THE FEDERAL POWER ACT
65
more than $10 million that is used for interstate wholesale sales and over which the Commission has jurisdiction for ratemaking purposes.11 Holding Companies. Prior Commission approval is required for a company that is a holding company (as defined by PUHCA)12 in a holding company system that includes a transmitting utility or an electric utility to (i) acquire any security with a value in excess of $10 million of a transmitting utility, an electric utility company, or a holding company in a holding company system that includes a transmitting utility, or an electric utility company or (ii) directly or indirectly merge or consolidate with an electric utility company, or a holding company in a holding company system that includes a transmitting utility, or an electric utility company.13 The following discussion is organized according to the different types of jurisdictional transactions commonly consummated by public utilities regulated by the Commission. First, asset dispositions are discussed, followed by transfers of jurisdictional contracts, mergers, reorganizations, and transfers of securities. The final subsection in this section addresses change in control issues generally and identifies certain types of agreements that may involve a change in control and thus be subject to prior Commission approval. As a general matter, the Commission historically has taken an expansive reading of its jurisdiction under section 203: Neither section 203 nor any other provision of the FPA defines the terms dispose, facilities subject to the jurisdiction of the Commission, merge, consolidate, and control. However, we do not believe these terms should be read narrowly. To do so would result in a jurisdictional void in which certain types of power sales facilities and corporate transactions could escape Commission oversight.14
11 12
Id. 824b(a)(1)(D).
The Public Utility Holding Company Act ( PUHCA ) of 1935 was repealed by EPAct 2005 and replaced by the PUHCA of 2005 ( PUHCA 2005 ). Under PUHCA 2005, a company is considered a holding company if it owns or controls 10 percent or more of any electric utility company or gas utility company. See. 16 U.S.C. 1262(8), 1262(14). PUHCA 2005 defines an electric utility company as any company that owns or operates facilities used for the generation, transmission, or distribution of electric energy for sale.Id. 1262(5). PUHCA 2005 defines a gas utility company as any company that owns or operates facilities used for distribution at retail (other than the distribution only in enclosed portable containers or distribution to tenants or employees of the company operating such facilities for their own use and not for resale) of natural or manufactured gas for heat, light, or power.Id. 1262(7).
13 14
16 U.S.C. 824b(a)(2). Enova Corp., 79 FERC 61,107, at 61,489 (1997).
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 1. Asset Transactions a. Transmission Facilities
The classic case of FERC jurisdiction under section 203 is the sale or lease by a public utility of transmission or interconnection facilities. In addition to transmission lines, facilities such as generator step-up transformers, generator leads, tie-lines, transformers, conductors, disconnect switches, and substations are considered transmission facilities for purposes of FERC jurisdiction under section 203.15 Any transfer of such assets valued at more than $10 million by a public utility requires prior FERC approval. 16 A transfer of distribution facilities only, however, does not trigger the prior approval requirement.17 If the seller of jurisdictional transmission facilities is a non-jurisdictional entity, such as a public power entity, normally the Commission would not have jurisdiction under section 203. If however, the purchaser of the facilities is a public utility, the Commission will assert section 203 jurisdiction.18 b. Generation Facilities Prior to passage of EPAct 2005, transfers or leases of generation facilities were not subject to section 203 jurisdiction unless they included associated jurisdictional assets (such as transmission facilities or wholesale sales contracts).19 However, EPAct 2005 added a new provision applicable to transactions that will close after February 8, 2006. The new provision
Note that generator step-up transformers are not considered transmission facilities for purposes of functionalizing facilities to develop rates under FPA section 205. Kentucky Utils. Co., 85 FERC 61,274, at 62,111-13 (1998). The 203 NOPR proposed to determine the value of transferred facilities using the market value, where available, or, alternatively, original cost undepreciated. 203 NOPR, 113 FERC 61,006 at PP 28-30. See Duke Power Co. v. FPC, 401 F.2d 930 (D.C. Cir. 1968). However, if distribution facilities also are used to make wholesale sales, section 203 jurisdiction will be asserted. See also Kandiyohi Power Coop., 107 FERC 61,285 (2004). See, e.g., Puget Sound Power & Light Co., 50 FPC 72 (1973); see also Duke Power, 401 F.2d at 937-38 (noting that the statutory language requiring approval when a public utility merges or consolidates its facilities with those of another person reflects Congressintention to govern acquisitions of jurisdictional facilities by public utilities); MidAmerican Energy Co., 112 FERC 62,025 (2005) (approving acquisition of jurisdictional facilities by public utility from nonjurisdictional entity); American Transmission Co., 106 FERC 62,005 (2004) (same); Florida Power Corp., 85 FERC 62,032 (1998) (same). See Perryville Energy Partners, 109 FERC 61,019 (2004) (disclaiming jurisdiction where seller kept interconnection facilities and provided service over them to buyer under a cost-ofservice transmission rate schedule); see also American Pub. Power Ass n, 94 FERC 61,104 (2001), aff d, Citizen Power Inc. v. FERC, 38 Fed. Appx. 18 (D.C. Cir.), cert. denied, 537 U.S. 1046 (2002). If the purchaser makes arrangements with the seller for service over step-up transformers or other interconnection facilities following the sale, such arrangements would be jurisdictional under section 205.
19 18 17 16 15
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requires prior FERC approval for a public utility to purchase, lease, or transfer an existing generation facility valued at more than $10 million20 in cases where the generation facility is used for interstate wholesale sales and over which the Commission has jurisdiction for 21 ratemaking purposes. Neither generation facilities located in the Electric Reliability Council of Texas ( ERCOT ) nor foreign generation facilities are subject to this provision because such generation facilities are not used for interstate wholesale sales and the Commission does not have ratemaking jurisdiction over such facilities. It is not clear whether the acquisition of a generating facility (i.e., the asset itself, as opposed to a company that owns a generating facility) by a holding company (or a subsidiary thereof that is not a public utility) is within the Commission s section 203 jurisdiction. The EPAct 2005 provision granting the Commission jurisdiction over certain transactions involving holding companies does not specifically mention acquisitions of generation facilities by holding companies,22 but it is not clear how the Commission will interpret its newly-granted authority to regulate holding companies. In addition to the prior approval requirements of FPA section 203, the Commission requires a separate notice of generating capacity acquisitions under the reporting requirements of section 205 for entities with market-based rate authority. Under Order No. 652, such entities must disclose a purchase or acquisition of control of generation facilities greater than 100 MW or inputs to electric power production (other than fuel) within 30 days of closing, even if that transaction does not trigger section 203 review and even if the seller s triennial market power update is not due.23 This reporting requirement under section 205 is discussed in more detail in Chapter 7 on Power Sales. Acquisition of a generating unit also may affect exempt wholesale generator status, as discussed in Chapter 15 on Exempt Wholesale Generators.
As noted above, the 203 NOPR proposed to determine the value of physical facilities using the market value, where available, or, alternatively, original cost undepreciated. 203 NOPR, 113 FERC 61,006 at PP 28-30. If the generation facility transfer or lease will close prior to February 8, 2006, it may still be subject to section 203 if jurisdictional facilities (e.g., generator step-up transformers or generator leads) are among the facilities being transferred. In that event, the Commission will review the entire transaction for consistency with the public interest. See Ameren Energy Generating Co., 108 FERC 61,081, at P 25 (2004) ( If a portion of a transaction requires authorization under section 203, the overall effect of the transaction must be considered before approval may be granted. We cannot ignore the full implications of a transaction for the public interest. ). In other words, the Commission will examine the effect on competition, regulation and rates of the transfer of the generation capacity, in addition to the transfer of the transmission or interconnection facilities.
22 23 21
20
See 16 U.S.C. 824b(a)(2) (amended FPA 203(a)(2)).
Reporting Requirement for Changes in Status for Public Utilities with Market-Based Rate Authority, Order No. 652, 70 Fed. Reg. 8253 (Feb. 18, 2005), III FERC Stats & Regs, Regs. Preambles 31,175, 110 FERC 61,097 ( Order No. 652 ), order on reh g, Order No. 652-A, 111 FERC 61,413 (2005).
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 2. Assignment or Transfer of Jurisdictional Contracts
FERC and the courts have interpreted jurisdictional facilities to include not only physical facilities, such as transmission lines and associated equipment, but also so-called paper facilities such as wholesale tariffs, rate schedules, power sales contracts and related accounts and records pertaining to wholesale sales or interstate transmission.24 Thus, if a public utility sells or assigns contracts for jurisdictional sales or services, rate schedules and tariffs (such as market-based rate tariffs), or books and records necessary to make jurisdictional sales, such sale or assignment must receive prior FERC approval if it is valued at more than $10 million.25 3. Mergers The merger of two public utilities is another classic transaction requiring prior section 203 approval. It is important to note that while all other transactions requiring prior approval under section 203 are subject by statute to a minimum jurisdictional trigger ($10 million), there is no such statutory threshold for mergers. Although EPAct 2005 codified the Commission s prior practice of asserting jurisdiction over mergers involving holding companies,26 it nevertheless has introduced some uncertainty into the exercise of that authority. For example, the language in amended section 203 appears to grant the Commission jurisdiction over mergers involving holding companies located in ERCOT and foreign holding companies. It is unclear whether the Commission will assert jurisdiction over transactions involving foreign utility companies or foreign holding companies.27 Another ambiguity caused by EPAct 2005 is the lack of a definition in the FPA of the term electric utility company. Amended section 203(a)(2) requires prior approval for a holding company to directly or indirectly merge or consolidate with an electric utility company or a holding company system that includes . . . an electric utility company. The FPA defines an electric utility as a person [defined as an individual or a 28 corporation] . . . that sells electric energy, while PUHCA defines electric utility companyas a company that owns facilities used for the generation, transmission, or
See, e.g., Enova Corp., 79 FERC 61,107 at 61,489 (1997) (citing Hartford Elec. Light Co., 131 F.2d 953, 961 (2d Cir. 1942), cert. denied, 319 U.S. 741 (1943) and Connecticut Light & Power Co. v. FPC, 324 U.S. 515, 528 n.6) (1945)). The Commission has proposed to value wholesale contracts by reference to total expected contract revenues over the remaining life of the contract. 203 NOPR, 113 FERC 61,006 at P 32.
26 27 25
24
See, e.g., Enova Corp., 79 FERC 61,107 at 61,491-96.
With respect to acquisitions of foreign utility companies by holding companies with no captive customers in the United States, the 203 NOPR sought comment on procedures the Commission might adopt, or safeguards it might require, to pre-approve or expedite such transactions while at the same time protecting U.S. captive customers.203 NOPR, 113 FERC 61,006 at P 60.
28
See 16 U.S.C. 796(4), (22).
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29 distribution of electric energy for sale. The 203 NOPR proposes to use the PUHCA 30 definition.
Finally, it is important to be aware of several requirements applicable to merger applicants beyond the obligation to file a request for prior approval under section 203. For example, when a merger transaction is announced, potential merger partners should be prepared to treat each other as affiliates by committing to seek prior section 205 approval for power sales between the merging companies (or their affiliates) if such sale involves a traditional franchised utility. The companies also must apply asymmetrical pricing rules for the sale of non-power goods and services, to the extent required for affiliate transactions under their respective codes of conduct.31 Thus, even before a section 203 application is submitted, potential merger partners should submit a notice of change in status under their market-based rate tariffs, notifying the Commission that they are potential affiliates and will conduct their trading according to the restrictions that apply to affiliates.32 In addition, under the Standards of Conduct, transmission-owning utilities involved in a pending merger transaction must post the name and addresses of potential merger partners on their OASIS.33 Public utilities involved in mergers also should be aware of obligations under section 20434 (relating to securities that may be issued or assumed as part of a merger transaction), section 20535 (relating to jurisdictional contracts executed or assigned as part of the merger transaction that may be jurisdictional), and section 30536 (relating to interlocking directorates established as part of the newly-formed entity).37
29 30 31 32
EPAct 2005 1262(5), 119 Stat. at 972. 203 NOPR, 113 FERC 61,006 at P 40. See, e.g., New Century Servs., Inc., 86 FERC 61,307, at 62,065 (1999).
While the Commission has not formalized or expressly required such filings, it has been the practice of many entities to submit pre-merger notices of change in status committing to treat prospective merger partners as affiliates for certain purposes. See Chapter 7, Affiliate Sales, and Chapter 11, Codes of Conduct, for further description of these requirements. Standards of Conduct for Transmission Providers, Order on Rehearing and Clarification, Order No. 2004-A, 69 Fed. Reg. 23,562 (Apr. 29, 2004), III FERC Stats. & Regs., Regs. Preambles 31,161, at P 168 (2004) ( Order No. 2004-A ).
34 35 36 37 33
16 U.S.C. 824c. Id. 824d. Id. 825d.
The Commission also has jurisdiction over the payment of dividends out of capital accounts, which is sometimes necessary following a merger conducted pursuant to the purchase method of accounting. Under that accounting method, retained earnings accounts are eliminated and the balances in those accounts are reflected in paid-in capital accounts. Under FPA section 305(a), public utilities may not pay dividends from capital accounts, which could interfere with a public utility s ability to pay dividends at historic levels, post-merger. 16 U.S.C. 825d(a). As a result, it may be necessary when a merger is conducted pursuant to the purchase accounting method to request a declaratory judgment from the Commission (as part of the merger application) that the future payment of dividends from capital accounts does not implicate section 305(a) under the
70
ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 4. Reorganizations
Internal corporate reorganizations that involve a change in upstream ownership also require prior Commission approval.38 In addition, parties have filed for section 203 authorization even for simple internal corporate restructurings that do not involve a change in upstream ownership, such as a change in the utility s state of incorporation. 39 These simple approvals usually are issued in about 35-40 days. The Commission has indicated that section 203 approval is not required in the limited circumstance where an applicant is eliminating an intermediate layer of ownership in a holding company structure.40 5. Purchase or Acquisition of Securities of a Public Utility The Commission possesses statutory jurisdiction over (1) a public utility s purchase of the securities valued at more than $10 million of another public utility, or (2) a holding company s purchase of the securities valued at more than $10 million of a transmitting utility, an electric utility company, or a holding company in a holding company system that includes a transmitting utility, or an electric utility company. The $10 million threshold was added by EPAct 2005, and it is unclear how that threshold will be interpreted in light of existing Commission precedent.41 In prior cases, the Commission has declined requests to disclaim jurisdiction over a public utility s acquisition of securities of another public utility, but has granted blanket authorization for a public utility to acquire up to five percent of each voting class of securities issued by a public utility provided that the acquisition of those securities confers no right to control the management or operation of the utility. 42 Given EPAct 2005 s adoption of a $10 million threshold, it is not clear whether the Commission would authorize a five percent standard in the future (i.e., whether the Commission will grant blanket authorization in cases involving more than $10 million but less than five percent of voting securities). It also is unclear whether, in light of the $10 million threshold, the Commission will require section 203 authorization in cases where the securities involved
circumstances presented. See, e.g., Exelon Corp., 109 FERC 61,172 (2004); Niagara Mohawk Holdings, Inc., 95 FERC 61,381 (2001); New England Power Co., 89 FERC 61,266 (1999). Enova Corp., 79 FERC 61,107 at 61,489-90 (noting that even where the public utility corporations or partnerships that own jurisdictional facilities are not themselves dissolved or extinguished, there may be a dissolution of one or more of the entities that own or control those public utilities, resulting in an indirect merger of the public utilities jurisdictional facilities ).
38
Dynegy, Inc., 111 FERC 62,153 (2005) (granting approval to change from an Illinois corporation to a Delaware corporation); Entergy La., Inc., 112 FERC 62,209 (2005) (granting approval to change from a Louisiana corporation to a Texas limited liability company). Usually, these filings are made out of an abundance of caution on the theory that such reincorporation legally dissolves and reforms the company. Similar circumstances may arise when a company changes its form, e.g., forms a limited partnership to a limited liability company.
40 41
39
Ocean State Power, 53 FERC 61,331, at 62,218 (1990).
The Commission has proposed to determine the value of securities by reference to the market price at the time the security is acquired. 203 NOPR, 113 FERC 61,006 at P 33.
42
UBS AG, 103 FERC 61,284, reh g granted, 105 FERC 61,078 (2003).
71
have a value below $10 million but constitute greater than five percent of the voting securities. Prior to passage of EPAct 2005, in cases where the Commission granted blanket authorization to hold voting securities below five percent, the Commission ordered the holder of such securities to make quarterly reports to the Commission of holdings above one percent.43 The Commission allowed a limited exception to this requirement in the case of certain debt securities held in connection with lending activities, fiduciary and underwriting activities, and dealing, trading and derivatives activities, under certain circumstances.44 In EPAct 2005, Congress adopted a similar securities acquisition provision for holding companies. The holding company provision applies to the acquisition of more than $10 million in securities of a transmitting utility, an electric utility company, or a holding company in a holding company system that includes a transmitting utility, or an electric 45 utility company. As discussed above, there is an ambiguity regarding the definition of electric utility company. Whether the FPA electric utilitydefinition or the PUHCA electric utility company definition is adopted by the Commission will determine whether certain security acquisitions are jurisdictional. For example, if the PUHCA definition applies and the Commission continues to interpret that definition in the same manner as the Securities and Exchange Commission ( SEC ), a holding company acquiring the securities of a power marketer would not be jurisdictional if the marketer did not own or operate facilities used for the generation, transmission, or distribution of electric energy for sale. As noted above, the 203 NOPR proposes to use the PUHCA definition. 46 Also, it is not clear whether the Commission will interpret electric utility company to exclude exempt wholesale generators and foreign utility companies, which had been excluded from the term electric utility company under PUHCA 1935. Notably, the PUHCA definition of holding companyadopted in EPAct 2005 excludes banks, brokers and other similar entities in certain circumstances.47 For example, a holding company does not include a bank that owns, controls or holds, with the power to vote, public utility securities so long as the bank holds the securities (i) as collateral for a loan, (ii) in the ordinary course of business as a fiduciary or (iii) for purposes of liquidation.48 A broker or dealer would not be considered a holding companyif it owns, controls, or holds, with the power to vote, public utility securities so long as the securities (i) are not beneficially owned by the broker/dealer and are subject to any customer voting instructions
43 44 45 46 47 48
Id. at P 7. Id. at P 9. 16 U.S.C. 824b(a)(2). 203 NOPR, 113 FERC 61,006 at P 40. EPAct 2005 1262(8), 119 Stat. at 972. Id. 1262(8)(B)(i).
72
or (ii) are acquired within 12 months in the ordinary course of business with the bona fide intention of distributing the specific securities.49 An issue pending before the Commission is the applicability of section 203 to intrasystem financing arrangements. Many holding companies systems utilize such money pooling arrangements in which associate companies in the same holding company system share available funds on a short-term basis in order to manage more effectively the immediate financial needs of the companies as a whole. Also, section 203 long has required a public utility to seek prior approval to acquire the security of another public utility. Given that securitiesare defined by FPA section 3(16) to include notes and other evidence of indebtedness, section 203 could be read to require prior Commission approval for loans (in excess of $10 million) made among public utility associate companies and loans (in excess of $10 million) made by a holding company to its subsidiary public utility company pursuant to cash management and other intra-system financing arrangements. Although the 203 NOPR did not raise this issue, in comments several utilities urged the Commission to continue its prior practice of addressing the issuance of securities under section 204(a) and the implementation of money pools using reporting requirements,50 rather than requiring prior approval under section 203. If the Commission asserts section 203 jurisdiction over such arrangements, the same utilities urged the Commission to allow companies to seek preapproval or blanket authorization for certain types or categories of transactions. 6. Change of Control Issues Generally If a transaction is not a sale, lease or merger, but nonetheless results in a direct or indirect change in control over a jurisdictional entity or facility, it still may trigger the requirement for prior approval under FPA section 203. Determining whether a transaction results in a change in control for purposes of section 203 is not always straightforward, and the Commission s policies in this area are still evolving. The Commission has conceded that it has not established a bright-line test for a percentage of ownership that constitutes control over, or ability to influence, an entity s actions and it has expressed an unwillingness to do so.51 Indeed, the Commission has recognized that it is difficult to identify every transaction that will trigger FERC jurisdiction. We acknowledge that we cannot definitively identify every combination of entities or disposition of assets that may trigger section 203 jurisdiction, since we cannot anticipate every type of restructuring that might occur. . . . However, it should be clear that our concern is with changes in control, including direct or 52 indirect mergers, that affect jurisdictional facilities (whether physical or paper facilities). The Commission s current interpretation of its section 203 authority relating to changes in control is broad, namely that a public utility is disposingof its jurisdictional
49 50
Id. 1262(8)(B)(ii).
See Regulation of Cash Management Practices, Order No. 634-A, 105 FERC 61,098 (2003) ( Money Pool Rule ); 18 C.F.R. Pt. 101, Account 146 (2005).
51 52
ITC Holdings Corp., 111 FERC 61,149, at P 24 (2005). Enova Corp., 79 FERC 61,107 at 61,496.
73
facilities when there is a direct or indirect change in corporate control over the utility. 53 Prior to the adoption of EPAct 2005, the Commission relied heavily on this change in control standard to expand its jurisdiction to include mergers involving public utilities. EPAct 2005 replaced section 203 s reference to control with change in control, presumably lending support to the Commission s continued use of the change in control standard. Nonetheless, it is uncertain how the Commission will treat changes in control involving holding companies given that section 203(a)(2) now expressly addresses which holding company transactions require prior Commission approval. While the Commission has not defined what percentage of voting securities or ownership constitutes a change in control, recently it has utilized a less than five percent threshold for purposes of defining future transactions that qualify for preauthorization.54 Given EPAct 2005 s provisions, the Commission may conclude that the $10 million threshold eliminates the need for any percentage-based threshold. Because the precedent on this issue is vague and the Commission acts quickly on applications that do not raise substantive issues under section 203, parties often request section 203 authorization for even small changes in ownership. Another type of transaction that may trigger FPA section 203 jurisdiction is a service agreement under which the owners of a generating facility confer a degree of control over plant operation and marketing to third parties. These so-called energy management agreements may require prior approval under section 203 if the third party exercises independent control over the operation of the facility or the marketing of its output such that the contract operator could limit or withhold the output of the facility as part of an effort to increase market prices.55 Though the Commission has identified this issue, precedent in this area is still evolving.56 The Commission has expressed similar concerns in the section 205 context, requiring companies with market based rate authority to file a notice of change in status where an entity acquires control over generation or transmission facilities.57 B. GENERATION TRANSACTIONS BETWEEN AFFILIATE
A
FRANCHISED UTILITY
AND ITS
UNREGULATED
As noted above, corporate reorganizations require prior approval under FPA section 203. The sale or lease of jurisdictional facilities between affiliates is an area of increasing scrutiny under section 203. In particular, the Commission has become concerned that the transfer of facilities from a merchant affiliate to a franchised utility may potentially be unfair because it may provide a safety net that unaffiliated generators lack when market
Id. A utility does not, however, dispose ofits facilities when it agrees to cede operational control of its facilities to an RTO. Atlantic City Elec. Co. v. FERC, 295 F.3d 1, 11 (D.C. Cir. 2002).
53
MACH Gen, LLC, 113 FERC 61,138, at P 40 (2005). This future authority was granted for transfers to buyers that are banks, institutional investors, financial institutions, investment companies, or related entities not primarily engaged in energy-related business activities and not acting on behalf of a public utility. Id. at P 38.
55 56 57
54
Similar issues may arise under other agreements that confer control over generation. See Central Miss. Generating Co., LLC, 106 FERC 61,006, at P 29 (2004). Order No. 652, 110 FERC 61,097 at P 47.
74
conditions are adverse.58 Generally, the Commission is of the view that acquisitions involving affiliates have an inherent potential for discriminatory treatment in favor of the 59 60 affiliate. Therefore, the Commission recently decided to apply its so-called Edgar standards to section 203 applications involving a franchised utility s purchase of generation assets from an unregulated affiliate.61 These standards are intended to ensure that the franchised utility does not in its acquisition favor its affiliate over nonaffiliates. Under the Edgar line of cases, a utility must demonstrate lack of affiliate abuse by showing either: evidence of direct head-to-head competition between affiliated and unaffiliated suppliers in a formal solicitation or information negotiation process; evidence of the prices that non-affiliated buyers were willing to pay; or benchmark evidence of the prices, terms and conditions of sales made by nonaffiliated sellers. Though the Commission did not require utilities to conduct competitive solicitations, it adopted RFP guidelines that, if followed, should greatly reduce application processing 62 time (including litigation) and increase the likelihood of timely Commission approval. C. ABSENCE OF JURISDICTION It is important to remember that the absence of section 203 jurisdiction over a sale or lease does not insulate a transaction from FERC scrutiny of resulting wholesale sales by the parties involved in the transaction, state prudence reviews, or the obligation to submit a notice of change in status under a market-based rate tariff. II. BRIEF OVERVIEW OF SECTION 203 APPROVAL CRITERIA AND PROCESS
While not squarely a compliance issue, section 203 approval criteria and process are considerations in conducting initial feasibility and timing analyses of a potential transaction that is or might be jurisdictional under section 203. A. APPROVAL CRITERIA The Commission must find a transaction to be consistent with the public interest in 63 order to approve it under section 203. In applying this public interest test, the Commission
58 59 60 61 62 63
See Ameren, 108 FERC 61,081 at P 11. Id. at P 59. See Boston Edison Co., 55 FERC 61,382 (1991). See Ameren, 108 FERC 61,081 at P 59. Id. at P 68.
Section 203 s phrase consistent with the public interest does not connote a public benefit to be derived or suggest the idea of a promotion of the public interest. . . . It is enough if the applicants show that the proposed merger is compatible with the public interest. Pacific Power &
75
generally considers three factors: whether the transaction will have an adverse effect on competition, an adverse effect on rates, or an adverse effect on regulation. EPAct 2005 provides an additional statutory criterion, obligating the Commission to find that the transaction will not result in cross-subsidization of a non-utility associate company or the pledge or encumbrance of utility assets for the benefit of an associate company, unless the Commission determines that the cross-subsidization, pledge or encumbrance will be 64 consistent with the public interest. It is unclear whether this newly-added criterion will heighten Commission review or whether the Commission will follow an approach similar to its approach under the effect on ratesand effect on regulationprongs. Under those prongs, the Commission has allowed applicants to provide certain assurances to address concerns regarding a transaction s effect on captive ratepayers or on regulation and thereby avoided the need for an in-depth review of those issues. FERC also may consider whether a merger affects reliability in a material way. A recent Commission policy statement, issued in response to a Commission Staff report on the August 2003 blackout, stated that the Commission considers the reliability implications of merger applications. 65 While this has not been an issue in merger cases, applicants should be prepared to respond to any comments on reliability issues. The standards utilized by the Commission to evaluate the three primary areas of FERC review (prior to EPAct 2005) are briefly summarized below. Effect on Competition: The purpose of the Commission s review of competition is to analyze whether a merger or acquisition will change market concentration levels sufficiently to give the applicants greater incentive or ability to profitably withhold output or foreclose rivals in an effort to raise prices. The Commission has adopted a horizontal screen analysis to enable the Commission to quickly identify proposed mergers or acquisitions that are unlikely to present competitive concerns. The required analysis was originally set forth in Appendix A of the Commission s Merger Policy Statement,66 and since has been incorporated into FERC s merger regulations.67 If a proposed combination or acquisition fails the screen, the Commission may require applicants to submit more detailed analyses to
Light Co. v. FPC, 111 F.2d 1014, 1016 (9th Cir. 1940). The Commission is required to evaluate whether the merger taken as a whole, is consistent with the public interest rather than to evaluate the effect of the merger on any one individual. Northeast Utils. Serv. Co. v. FERC, 933 F.2d 937, 951 (1st Cir. 1993).
64 65
16 U.S.C. 824b(a)(4).
See Policy Statement on Matters Related to Bulk Power System Reliability, Policy Statement on Matters Related to Bulk Power System Reliability, 107 FERC 61,052, at P 37 (2004); see also U.S.-Canada Power System Outage Task Force, Final Report on the August 14, 2003 Blackout in the United States and Canada: Causes and Recommendations, at 147 (April 2004) (recommending that the Commission incorporate a formal reliability impact consideration in reviewing proposed mergers). Inquiry Concerning the Commission s Merger Policy Under the Federal Power Act, Order No. 592, 77 FERC 61,263 (1996).
66 67
18 C.F.R. 33.3.
76
rebut the presumption of market power. Typically, in cases where a combination or acquisition produces screen failures, the initial merger application will contain proposed mitigation measures (e.g., generation auctions, generation divestures) and analyses demonstrating that the proposed mitigation measures eliminate screen failures. Horizontal mergers or asset sales involving entities that do not own assets in the same geographic markets are exempt from providing the full competitive analysis screen. 68 Vertical merger applications (those involving entities that own both generation and inputs to generation) are subject to an additional competitive analysis. If the upstream merging firm sells a product that produces a de minimus amount of the relevant product in the downstream geographic market, or sells no product in the downstream electricity geographic market, only minimal information and analysis is necessary.69 If a full vertical competitive analysis is needed, merging companies must (1) define the relevant products sold by the merging firms; (2) define the relevant geographic markets; (3) evaluate competitive conditions using market share and concentration HHI statistics in the respective geographic markets; and (4) evaluate potential adverse effects of the proposed merger in these markets, along with other factors that could counteract such effects.70 The Commission also considers whether an applicant s ownership of electric transmission facilities raises vertical market power concerns. In at least one case, the Commission considered whether a proposed transaction raised transmission market power concerns, even where the applicants had open access transmission tariffs on file.71 Effect on Regulation: Prior to the passage of EPAct 2005, the Commission s primary concern in reviewing a transaction s effect on regulation was the potential effect on its own jurisdiction when a registered holding company was formed, thus invoking SEC jurisdiction. In EPAct 2005, however, Congress repealed the PUHCA of 1935, thus there is no longer a 72 concern about any potential shift in regulation from [the] Commission to the SEC. The Commission, however, has proposed that applicants are still required to address whether the 73 transaction will have any other effect on the Commission s regulation. It is unclear how PUHCA repeal will affect the Commission s evaluation of this prong of its analysis. In addition to its concern over holding company issues, the Commission also has used this prong in the past to address concerns regarding state jurisdiction. Under this prong, the Commission requires applicants to state whether state regulatory bodies have jurisdiction to
68 69
Id. 33.3(a)(2)(i).
Revised Filing Requirements Under Part 33 of the Commission s Regulations, Order No. 642, 65 Fed. Reg. 70,984 (Nov. 28, 2000), FERC Stats. & Regs., Regs. Preambles July 1996-Dec. 2000 31,111, at 31,903 (2000) ( Order No. 642 ), order on reh g, Order No. 642-A, 94 FERC 61,289 (2001).
70
Order No. 642, FERC Stats. & Regs., Regs. Preambles July 1996-Dec. 2000 31,111, at See Oklahoma Gas & Elec. Co., 105 FERC 61,297, at P 35 (2003). 203 NOPR, 113 FERC 61,006 at P 67. Id.
31,903-04.
71 72 73
77
review the merger, and reserves the ability to investigate state regulatory concerns raised by states that do not have such jurisdiction.74 Effect on Rates: Applicants have the burden to prove that wholesale ratepayers will not be harmed by the merger. This burden can be discharged in a number of ways. For example, applicants can show that all customers are served under fixed rates or are located in a retail access state so they are not captiveand have the option to purchase from a competitive supplier. Alternatively, if the applicants have long-term contracts with rate adjustment clauses, the applicants can propose a rate freeze or open season to protect such customers. Any such ratepayer protection mechanisms must clearly identify what customer groups are covered, what costs are covered, and the time period of the protection.75 Often, applicants make a hold-harmless ratepayer protection commitment, stating that applicants will not include merger-related costs in rates unless they can show that such costs are offset by merger-related benefits. B. APPROVAL PROCESS Upon receipt of a FPA section 203 application, the Commission issues a notice of filing requiring comments within 15 to 60 days, depending on the nature of the filing and whether the applicants submitted detailed market power studies. The majority of section 203 transactions, particularly those involving internal reorganizations, sales of transmissionrelated facilities, and mergers or acquisitions where there is no material overlap in generation ownership among the applicants, are approved on a delegated basis by the Director, Division of Tariffs and Market Development. Approval under delegated authority is permissible when there are no protests or substantive interventions. Usually, such approvals are issued within four to eight weeks of filing. If substantive issues are raised in protests to a section 203 application, the review process will take considerably longer and will require an order of the Commission. For example, controversial merger transactions, particularly those involving vertically integrated utilities that own generation facilities in the same market, often have been set for hearing or further procedures. In the past, such proceedings have taken from 12 to 24 months to resolve. Committing upfront in an application or in an answer to protests to mitigate adverse effects of the transaction can speed the approval process and avoid a hearing.76 In addition to expanding the scope of transactions subject to prior approval, EPAct 2005 also imposed new requirements for Commission consideration of FPA section 203 transactions. First, the Commission is required to adopt new procedures for the expeditious considerationof section 203 applications. Those procedures must identify classes of transactions, or specific criteria for transactions, that normally meet the approval standards, and the Commission must provide expedited review for those transactions. All applications
74
Order No. 642, FERC Stats. & Regs., Regs. Preambles July 1996-Dec. 2000 31,111 at Id. at 31,914. See, e.g., Exelon Corp., 112 FERC 61,011 (2005).
31,914-15.
75 76
78
are deemed granted if the Commission does not rule on them within 180 days, unless a good causetolling order is issued, which will provide for an additional 180 days. Thus, under EPAct 2005, the Commission is required to resolve even the most complicated applications in just under one year. It is important to note that it is not sufficient to mention a jurisdictional transaction to the Commission in the course of a different filing, such as a section 205 submittal. If the transaction is jurisdictional, a formal application under section 203 is necessary. 77 III. REMEDIES FOR NONCOMPLIANCE As noted above, EPAct 2005 granted the Commission civil penalty authority to punish violations of FPA section 203 in an amount up to $1,000,000 per day per violation, though this authority has not yet been exercised. As noted in the Overview of this Chapter, in several orders issued in the first half of 2005, before the passage of the EPAct 2005, the Commission stated that while it did not have civil penalty authority . . . the Applicants failure to obtain prior Commission approval for [a section 203 jurisdictional] transaction is 78 the type of violation for which the imposition of a penalty would be appropriate. Further, the Commission has stated, we take [section 203] violations seriously, and we expect public utilities that are planning transactions that may be jurisdictional to come to the Commission 79 for guidance, before consummating the questionable transactions. These statements suggest that the Commission is likely to use its new civil penalty authority to encourage future compliance with section 203. The Commission evaluates late-filed section 203 applications based on present day circumstances and approves them if it believes that the analysis of competitive, rate, or regulatory effects would not be materially different than it would have been at the time of the transaction.80 Nevertheless, the Commission has reminded public utilities that its approval of a transaction that already has closed does not provide insulation from requests by affected parties for a court to void a transaction that was consummated without prior approval. 81 IV. COMPLIANCE RECOMMENDATIONS It is critical to ensure that all jurisdictional transactions or reorganizations are submitted to the Commission prior to being consummated. For transactions where it is not clear whether section 203 applies, companies should consider requesting a ruling disclaiming
See PDI Stoneman, Inc., 104 FERC 61,270, at P 26 (2003) ( Unless a filing expressly applies for Commission approval for a specific 203 transaction, it is assumed that such approval has not been sought. ).
77
Puget Sound Energy, Inc., 110 FERC 61,161 at P 16 (2005); see also Mesquite Investors L.L.C., 111 FERC 61,162, at P 19 (2005); Northern Iowa Windpower II LLC, 110 FERC 61,059, at P 13 (2005).
79 80 81
78
Kandiyohi Power Coop., 107 FERC 61,285 (2004). See id. at P 10; PDI Stoneman, 104 FERC 61,270 at P 19. See id.
79
jurisdiction or simply consent to section 203 jurisdiction and request expedited approval. Public utilities should take steps to ensure that all legal and business staff are aware of the section 203 requirements and understand the importance of identifying potentially jurisdictional transactions before they are consummated. Companies should develop a checklist of the types of transactions and activities that could possibly trigger approval under section 203 and require business staff to consult with counsel if any of those transactions are contemplated.82 Given that transactional lawyers typically are involved early on in potential transactions, companies should train them to spot fact patterns that may result in transactions that are or may be jurisdictional under section 203.83 FPA section 203 compliance issues also arise in the post-approval stage of a merger transaction. Once a transaction is approved, the applicant typically is required to notify the Commission within 10 days of consummation of the transaction. Also, applicant commitments during the approval phase or FERC-imposed conditions must be tracked. Mergers, for example, are often conditioned on the applicants enforcing customer protection mechanisms, upgrading transmission capacity, implementing independent market monitoring mechanisms, holding annual energy auctions, divesting generation, or increasing reporting to the Commission. The Commission closely monitors the implementation and effectiveness of these applicant commitments.84 Accordingly, it is important that a system be developed by the company s regulatory staff to track ongoing compliance with these types of obligations.
See Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 113 FERC 61,068, at PP 2, 22 (2005) ( Enforcement Policy Statement ). More generally, see Chapter 1, The Hallmarks of a Successful Compliance Program, for a description of how to develop a compliance program consistent with the Commission s Enforcement Policy Statement. See, e.g., Oklahoma Gas & Elec. Co., Deficiency Letter, Docket No. EC03-131-000 (Sept. 21, 2005) (requesting detailed operational information about a facility constructed in compliance with an applicant commitment).
84 83
82
Chapter 6 Section 204 of the Federal Power Act: Issuance of Securities and Assumption of Liabilities
DAVID R. JANKOWSKY Section 204 of the Federal Power Act ( FPA ) grants the Federal Energy Regulatory Commission ( F E R C o r Commission ) jurisdiction to regulate the issuance of securities and the assumption of liabilities in respect of securities by public utilities.1 The primary purpose of section 204 is to ensure the financial viability of public utilities obligated to serve consumers of electricity.2 Historically, section 204 has generated much less controversy at the Commission than many other sections of the FPA. In addition, much of the responsibility for regulating security issuances of public utilities is given to the states (or, until the recent repeal of the Public Utility Holding Company Act of 1935, as amended ( PUHCA 1 9 3 5 ), to the Securities and Exchange Commission ( SEC )). Therefore, not surprisingly, Commission guidance on compliance under section 204 is relatively limited. There are signs, however, that the Commission will occupy a greater role in regulating public utility security issuances in the future. For instance, as discussed more fully below, no doubt influenced by the collapse of Enron and others, the Commission recently issued a landmark order prohibiting the use of proceeds from debt issuances secured by utility assets for non4 utility purposes.3 Furthermore, while the Energy Policy Act of 2005 ( E P A c t 2 0 0 5 ) did not amend FPA section 204 directly, it significantly altered the regulatory landscape under that section in two ways. First, EPAct 2005 repealed both PUHCA 1935 and section 318 of the
1
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Section 204 provides in pertinent part:
No public utility shall issue any security, or assume any obligation or liability as guarantor, indorser, surety, or otherwise in respect of any security of another person, unless . . . upon application by the public utility, the Commission by order authorizes such issue or assumption of liability. The Commission shall make such order only if it finds that such issue or assumption (a) is for some lawful object, within the corporate purposes of the applicant and compatible with the public interest . . . and (b) is reasonably necessary or appropriate for such purposes. 16 U.S.C. 824c(a) (2004). See Merrill Lynch Commodities, Inc., 108 FERC 61,233, at P 16 n.11 (2004) (citing Citizens Energy Corp., 35 FERC 61,198, at 61,455 (1986) and Howell Gas Mgmt. Co., 40 FERC 61,336, at 62,026 (1987)).
3 2
See Westar Energy, Inc., 102 FERC 61,186 (2003), clarified, 104 FERC 61,018 Pub. L. No. 109-58, 119 Stat. 594 (2005).
(2003).
4
82
FPA, which had provided that the SEC preempted Commission jurisdiction over security issuances by subsidiaries of registered public utility holding companies. 5 Second, EPAct 2005 expanded t h eC o m m i s s i o n sa u t h o r i t yt op u n i s hv i o l a t i o n so ft h eFPA, including 6 violations of section 204 and the orders issued thereunder. Accordingly, understanding FPA se c t i o n2 0 4a n dt h eC o m m i s s i o n sr e g u l a t i o n sand policies implementing it has become increasingly important. This chapter will discuss: (i) the extent of Commission jurisdiction under FPA section 204, (ii) the requirements for Commission approval of individual issuances and blanket authorizations, (iii) the procedures used to obtain such approvals, and (iv) compliance issues and recommendations. I. COMMISSION JURISDICTION UNDER FPA SECTION 204
Commission authorization under FPA section 204 is required only if: (i) the entity seeking approval is a public utility; (ii) the proposed issuance involves a security or the assumption of a liability or obligation in respect of any security; and (iii) Commission jurisdiction is not otherwise precluded under the statute.7 Absent the above, the Commission does not have jurisdiction to regulate the issuance of securities by public utilities. A. PUBLIC UTILITIES The Commission has authority under FPA section 204 to regulate only public utilities. This jurisdictional limitation is important because it means that issuances of securities by holding companies and affiliates of public utilities do not require section 204 authorization unless those companies are also public utilities or unless the securities issued are backed by the assets of a public utility. 8 Section 201(e) of the FPA defines a public utility as any person who owns or operates facilities subject to the jurisdiction of the 9 Commission. Facilities subject to the jurisdiction of the Commission include facilities for . . . [the] transmission of electric energy in interstate commerce and . . . the sale of electric
See id. 1277, 119 Stat. at 978 (repealing 16 U.S.C. 825q and amending 16 U.S.C. 824(g)(5)). See id. 1284(e), 119 Stat. at 980 (amending FPA section 316A, 16 U.S.C. 825o-1). Furthermore, the penalty ceiling has been raised from $10,000 to $1,000,000 per day for each violation. See id. Ad e t a i l e d d i s c u s s i o n o f t h e C o m m i s s i o n s n e wp e n a l a u t h o r i t y is found in Chapter 3 of this Handbook.
7 8 6 5
See 16 U.S.C. 824c.
In the latter case, there would be no need for approval of the issuance by the holding company or affiliate, but section 204 approval would be needed by the public utility seeking to backstop it. See Gulf States Utils. Co. v. FPC, 411 U.S. 747, 750 (1973) (applying section 201(e) of the FPA to analyze the scope of FPC jurisdiction under section 204); Jersey Cent. Power & Light Co. v. FPC, 319 U.S. 61, 63 (1943) (same); City of Lafayette v. SEC, 454 F.2d 941, 944 (D.C. Cir. 1971) (same); Mu l t i t r a d e L t d . P s h i p , 63 FERC 61,252 (1993); UtiliCorp United Inc., 59 FERC 61,220 ( 1 9 9 2 ) ( UtiliCorp ) .
9
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10 energy at wholesale in interstate commerce. As such, any company transmitting electric energy in interstate commerce or selling electric energy at wholesale in interstate commerce is a public utility for purposes of section 204.11 Importantly, as two recent decisions demonstrate, the Commission makes no distinction whether the public utility is investorowned or not-for-profit.12
B. SECURITIES An issuance or assumption of liability must involve a security to fall under the ambit of FPA section 204. A security is defined in section 3(16) of the FPA as any note, stock, treasury stock, bond, debenture, or other evidence of interest in or indebtedness of a 13 corporation subject to the provisions of this Act. While the applicability of section 204 to the issuance of stocks and bonds is straightforward, determining when the proposed issuance involves a security can be difficult in some instances. For example, it is not entirely clear whether a public utility requires Commission authorization when it enters into a loan or credit agreement. In several orders, the Commission has granted authorizations to public utilities seeking approval under section 204 to borrow under loan or credit agreements.14 H o w e v e r , t h eC o m m i s s i o n sd e c i s i o ni nUtilicorp suggests that such agreements are not evidence of indebtednessfor purposes of section 204 and therefore not securities. 15 As
10 11 12
16 U.S.C. 824(b)(1). City of Lafayette, 454 F.2d at 944.
See ISO New England, Inc., 97 FERC 61,304 (2001) (holding that FERC authorization is required for a self-funded not-for-profit independent system operator seeking to borrow $40 million under an existing credit facility); California Power Exch. Corp., 86 FERC 62,195 (1999) (holding that FERC authorization is required for a not-for-profit public benefit corporation to issue long-term debt).
13 14
16 U.S.C. 796(16).
See NewCorp Res. Elec. Coop., 104 FERC 62,155 (2003) (approving request to borrow $ 3 1 . 5m i l l i o n u n d e r a b a n k l o a n s e c u r e d b y a p p l i c a n t s j u r i s d i c t i o n a l t r a n s m i s s i o n a s s e t s ) ; Fall River Rural Elec. Coop., 104 FERC 62,156 (2003) (approving request to borrow approximately $13 million under a master loan agreement with the National Rural Utilities Cooperative Finance C o r p o r a t i o n( C F C ) ) ; Smarr EMC, 91 FERC 62,187 (2000) (approving request to borrow up to $195 million under a loan agreement with the CFC over a two-year period); Oregon Trail Elec. Consumers Coop., Inc., 79 FERC 62,142 (1997) (approving request to enter into and borrow funds under a $5 million line-of-credit agreement with the CFC); Pacific Nw. Generating Coop., 78 FERC 62,002 (1997) (approving request to enter into a 12-month revolving line of credit agreement with the CFC under which applicant would borrow up to $5 million); California Power Exch. Corp., 86 FERC 62,195 (1999) (approving request to acquire loans or other evidences of indebtedness on a revolving basis with no more than $500 million outstanding at any one time). In Utilicorp, a parent company with several unregulated subsidiaries asked FERC to d i s c l a i mj u r i s d i c t i o nu n d e r s e c t i o n2 0 4w h e nl e n d i n gi n s t i t u t i o n s d i s s a t i s f i e dw i t h c o m f o r t l e t t e r s r e q u e s t e d t h a t t h e p a r e n t c o m p a n y f o r m a l l y g u a r a n t e e i t s s u b s i d i a r i e s c o n t r a c t u a l o b l i g a t i o n s t o t h i r d parties. See 59 FERC at 61,755. Somewhat unusually, the parent company was itself a public utility and the state in which it was incorporated did not regulate the issuance of securities. See id. U t i l i C o r p a r g u e d t h a t t h e c o n t r a c t u a l g u a r a n t e e s a t i s s u e w e r e n o t i n r e s p e c t o f a n y s e c u r i t y b e c a u s e i t s s u b s i d i a r i e s c o n t r a c t u a l o b l i g a t i o n s w e r en o t i nt h ef o r mo f s e c u r i t i e s a n dt h u s f e l l o u t s i de the
15
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such, it is hard to reconcile Utilicorp w i t ht h eC o m m i s s i o n s subsequent orders approving borrowing under credit and loan agreements and other financial instruments.16 To mitigate compliance risk, when in doubt over whether an issuance involves a security, one conservative approach would be to seek a disclaimer of jurisdiction from the Commission.17 Alternatively, in some cases, it may be more efficient to ask the Commission to assume jurisdiction rather than address the sometimes difficult issues that can arise in a disclaimer request. C. OTHER JURISDICTIONAL LIMITS Section 204 specifically excludes from Commission jurisdiction certain issuances and assumptions. The Commission does not have jurisdiction either when the proposed issuance or assumption: (i) involves the issuance by a public utility of short-term debt maturing not more than one year after issuance and aggregating not more than five percent of the par value o f t h e u t i l i t y s o t h e r s e c u r i t i e s t h e n o u t s t a n d i n g ,18 or (ii) involves the issuance of securities by a public utility organized and operating in a state that regulates the issuance of such securities.19 As most states regulate the issuance of securities by public utilities, an applicant should make sure that no state commission has jurisdiction over the issuance before seeking FERC approval. II. COMMISSION APPROVAL
Three basic requirements must be met before the Commission may approve the issuance of a security or assumption of a liability in respect of a security. The issuance or assumption: (i) must be for some lawful object, within the corporate purposes of the applicant and compatible with the public interest; (ii) must be necessary or appropriate for the proper performance by the applicant of service as a public utility; and (iii) will not impair
C o m m i s s i o n s j u r i s d i c t i o n .Id. at 61,758. The Commission agreed, reading section 204 narrowly to hold that prior Commission approval was only required when a parent seeks to guarantee subsidiary o b l i g a t i o n s of a like kind to notes, stocks, treasury stocks, bonds, and debentures. All other g u a r a n t e e s a r e n o t s u b j e c t t o t h e C o m m i s s i o n ' s l i m i t e d j u r i s d i c t i o n u n d e r s e c t i o n 2 0 4 o f t h e F P A . Id. at 61,759 (emphasis added) (citing Association of American R.R. v. United States, 603 F.2d 953, 96364 (D.C. Cir. 1979) (construing section 20a of the Interstate Commerce Act, the statute on which FPA section 204 was modeled)). A possible reason for this discrepancy is that it is common for the Commission to assume jurisdiction, even where jurisdiction over a particular type of transaction is unclear, when asked to do so by the applicant. T h eC o m m i s s i o n sr e g u l a t i o n sa l s op e r m i tc o m p a n i e st os e e k i n f o r m a l a d v i c ea n d a s s i s t a n c e f r o mC o m m i s s i o n s t a f f . 1 8 C . F . R . 388.104(a). Unlike a formal order, such advice does n o t r e p r e s e n t t h e o f f i c i a l v i e w s o f t h e C o m m i s s i o n . Id. However, the Commission recently acted t oa f f i r m a t i v e l ys t r e n g t h e nt h ev a l u eo f s u c hi n f o r m a l a d v i c eb ya d o p t i n gas t a f f n o -a c t i o n l e t t e r process similar to that employed by the SEC. See Informal Staff Advice on Regulatory Requirements, 113 FERC 61,174 (2005).
17 18 19 16
16 U.S.C. 824c(e). Id. 824c(f).
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20 t h e a p p l i c a n t s a b i l i t y t op e r f o r mt h a t s e r v i c e . Thus, the Commission will inquire into the purpose of the issue and the use to which its proceeds will be put. Th eS u p r e m eC o u r t s landmark decision in Gulf States Utilities Co. v. FPC21 held that the Commission also must consider the anticompetitive consequences flowing from the issuance of a security as part of its statutory duty to ensure that the issuance or assumption is for a lawful object, compatible with the public interest.22 Appellate courts interpreting that decision, however, have given the Commission the broad deference generally afforded to administrative agencies in making that predictive determination.23 Thus, absent a clear indication that the proceeds of the issuance will be used for an unlawful purpose or to facilitate anti-competitive behavior, the Commission will generally authorize such issuances.
A. THE WESTAR ORDERS In addition to the above statutory requirements, the Commission recently announced in Westar Energy, Inc.24 that it intended all future issuances of secured and unsecured debt 25 authorized by the Commission to be conditioned on the following restrictions: Public utilities seeking authorization to issue debt secured by utility assets must use the proceeds of such debt for utility purposes only; If any utility assets that are used to secure debt issuances are divested or spunoff , the debt must follow the asset and be divested or spun-off as well; If any of the proceeds from unsecured debt are used for non-utility purposes, the debt must follow the non-utility assets; If the non-utility assets are divested or spun-off , then a proportionate share of the debt must follow the divested or spun-off non-utility asset; and
20 21 22
16 U.S.C. 824c(a) (2000). 411 U.S. 747 (1973).
Gulf States Utils. Co., 411 U.S. at 757; see id. a t 7 5 9( U n d e r t h e express language of 204 the public interest is stressed as a governing factor. There is nothing that indicates that the meaning of that term is to be restricted to financial considerations, with every other aspect of the public interest ignored. . . . Without a more definite indication of contrary legislative purpose, we shall not read out of 204 the requirement that the Commission consider matters relating to both the broad purposes of the Act and the fundamental national economic policy expressed in the antitrust l a w s . ) . See Michigan Pub. Power Agency v. FERC, 963 F.2d 1574, 1579-81 (DC Cir. 1992) ( u p h o l d i n gt h eC o m m i s s i o n sd e n i a lo fi n t e r v e n o r s p r o t e s tw h e r et h eC o m m i s s i o nf o u n dt h a t intervenors had not shown that anticompetitive activity would occur as a result of the authorization).
24 25 23
102 FERC 61,186 (2003), clarified, 104 FERC 61,018 (2003). Westar Energy, Inc., 102 FERC 61,186 at P 1.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK If utility assets financed by unsecured debt are divested or spun-off to another entity, then a proportionate share of the debt must also be divested or spun26 off.
The Commission explained that the additional restrictions are necessary to confront the proliferation of public utilities borrowing substantial amounts of money to invest in nonutility businesses and assets, thereby putting at risk their utility operations to the detriment of their electric consumers.27 In a subsequent order, the Commission clarified certain issues raised by the Westar restrictions.28 First, the above restrictions are not retroactively applied to debt issuances occurring prior to the order.29 Second, power marketers typically granted blanket authorization under FPA section 204 are not subject to the Westar restrictions.30 Third, unsecured debt used to purchase an asset must follow that asset upon divestiture, regardless of whether such divestiture is to an affiliated or non-affiliated entity.31 Finally, although public utilities are prohibited from using the proceeds from debt secured by a utility asset for non-utility purposes, nothing prevents a public utility from issuing unsecured debt for nonutility purposes.32 The Westar orders present certain compliance issues. First, the utilityor nonutility purposes for which secured or unsecured debt may or may not be used are not defined by the Commission. Instead, the Commission will make such determinations on a case-bycase basis after carefully considering all facts and circumstances for a specific debt 33 issuance. A potential consequence of the lack of guidance is that a public utility may have to re-apply for Commission approval if the proceeds of its previously authorized debt issuance are used for a purpose not expressly authorized by the Commission, even if such purpose is otherwise in compliance with Westar. Second, it is not clear whether a public utility must seek Commission approval to pledge utility assets as security for existing debt used for non-utility purposes when such pledge does not involve the issuance of a security. Third, the Commission did not expressly prohibit negative covenants in indentures and other similar agreements preventing the movement of debt from one entity to another.34 Thus, it is not clear whether the Commission will approve the issuance of a security that by its terms prevents the applicant from complying with the general requirement under Westar that debt
26 27 28 29 30 31 32 33 34
Id. at PP 20-21. Id. at P 22. See Westar Energy, Inc., 104 FERC 61,018 (2003). Id. at P 16. Id. at P 16 n.12. Blanket authorizations are discussed immediately below in Part II.B. Id. at PP 20-21. Id. at P 24. Id. at P 26. Id. at P 14.
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must follow the associated assets.35 As the Westar requirements are relatively new, it is likely that the above compliance ambiguities and others will be addressed by the Commission in future orders. B. BLANKET AUTHORIZATIONS Although the requirements of section 204 are statutory and thus cannot be waived, the Commission traditionally grants blanket authorizations for the issuance of securities and the assumption of liabilities to independent and affiliated power marketers and power sellers who are not subject to cost-based rate regulation typically in the context of a market-based rate application.36 As the Commission explained, since the purpose of section 204 is to ensure the financial viability of public utilities obligated to serve electric consumers, prior authorization is appropriate for independent and affiliated power marketers and power sellers with market-based rates who do not intend to become public service franchises with captive customers.37 The Commission, however, has refused to grant blanket authorizations to other entities.38 Effectively, the blanket authorizations waive the requirements of Part 34 of the C o m m i s s i o n s r e g u l a t i o n s a n d a l l o wa n e n t i t y t o i s s u e s e c u r i t i e s a n d a s s u m e liabilities in the future without the need for Commission approval. The Commission generally issues blanket authorizations through delegated letter orders and establishes a notice period (typically thirty days) in which third parties may protest the blanket authorization. At the end of the notice period, absent any protests, the entity is free to issue securities and assume liabilities, provided that such issuances and assumptions comply with section 204.39 III. PROCEDURE A public utility seeking Commission authorization under FPA section 204 must 40 c o m p l y w i t h P a r t 3 4 o f t h e C o m m i s s i o n s r e g u l a t i o n s . Among other things, the application must set forth: (i) a full description of the securities proposed to be issued, (ii) the purpose(s)
While not expressly prohibiting negative covenants, the Commission did state that p ublic utilities that become subject to the four restrictions originally set forth in the Westar Order must follow those restrictions and should not enter into any agreements, including indentures, that would prevent them from satisfying those restrictions. Id (footnote omitted). Such language suggests that the Commission may in the future deny an application involving a security containing such restrictions. See Merrill Lynch Commodities, Inc., 108 FERC 61,233 at P 16 & n.10 (citing Golden Spread Elec. Coop., 97 FERC 61,025, at 61,069 (2001)).
37 38 36 35
See Merrill Lynch Commodities, Inc., 108 FERC 61,233 at P 16 & n.10.
See Conjunction LLC, 103 FERC 61,198 (2003) (refusing to grant blanket authorizations to a transmission provider); Sea Breeze Pac. Juan de Fuca Cable, LP, 112 FERC 61,295, at P 39 (2005) (same). This delay in the effectiveness of blanket authorizations raises a special challenge for compliance personnel, who need to ensure that the notice period is not overlooked following the issuance of a favorable order by business units eager to proceed. During that period, the applicant does not have blanket prior authorization to issue securities and assume liabilities.
40 39
18 C.F.R. 34.1-34.10 (2005).
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for which the securities are to be issued, and (iii) a detailed statement of fact that the issuance will comply with the statutory requirements of section 204. 41 In addition, as part of their a p p l i c a t i o n , a p p l i c a n t s t y p i c a l l y r e q u e s t w a i v e r o f t h e C o m m i s s i o n s c o m p e t i t i v e b i d d i n g and negotiated placement requirements set forth in 18 C.F.R. 34.2. Just recently, the C o m m i s s i o na m e n d e dP a r t3 4o f t h eC o m m i s s i o n sr e g u l a t i o n st or e q u i r ea p p l i c a n t st o submit their applications electronically, dispensing with the requirement for paper filings.42 After receipt of the application at the Commission, notice of the application is published in the Federal Register. If no petition, protest or request opposing the granting of the application is received by the Commission during the notice period, the Commission will generally rule on the security issuance through a delegated staff order.43 Commission authorization for the issuance of securities is typically valid for a period of two years.44 After such time, an applicant must re-apply to the Commission to issue securities or assume liabilities. Further, the applicant must file a report with the Commission no later than thirty days after the sale or placement of long-term debt or equity securities pursuant to the terms of the order.45 Finally, as a compliance issue, it is important to note that any issuance of securities must be specifically tailored to the timing, type of issuance and purposes expressly authorized by the Commission in its order and all issuances of secured and non-secured debt must comply with the Westar requirements set forth above. IV. COMPLIANCE P r i o rt ot h ee n a c t m e n to fE P A c t2 0 0 5 ,t h eC o m m i s s i o n sa u t h o r i t y to impose penalties for violations of FPA section 204 was extremely limited. 46 Going forward, however, it is likely that the Commission will punish violations of section 204 by exercising its newly-expanded authority to impose civil penalties under FPA section 316A.47 It is not
41 42
See id.
See Electronic Filing of the Application for Authorization for the Issuance of Securities or the Assumption of Liabilities, Order No. 657, 111 FERC 61,282 (2005).
43 44
For examples of such orders, see supra note 14.
See, e.g., Fall River Rural Elec. Coop., 104 FERC 62,156, at 64,428 (2003). But cf. California Power Exch. Corp. , 8 6F E R C 6 2 , 1 9 5 , a t 6 4 , 2 5 7( 1 9 9 9 ) ( p e r m i t t i n gt h ea p p l i c a n t t o a c q u i r e l o a n s o r o t h e r e v i d e n c e s o f i n d e b t e d n e s s o n a r e v o l v i n g b a s i s f o r 3 3m o n t h s w i t h n o t m o r e t h a n $ 5 0 0 m i l l i o n o u t s t a n d i n g a t a n y o n e t i m e ) .
45 46
18 C.F.R. 34.10.
T h e C o m m i s s i o n s a u t h o r i t yt oi m p o s e c i v i l p e n a l t i e s u n d e r F P As e c t i o n3 1 6 Ad i dn o t previously extend to violations of FPA section 204. See 16 U.S.C. 825o-1(a) (2004) (limiting civil penalties to violations of sections 211 through 214 of the FPA). Thus, penalty exposure under section 204 was limited to willful violations of explicit orders, punishable by a civil penalty of up to $1,000 under section 315 of the FPA or by a criminal fine of up to $5,000 under section 316 of the FPA. Our research indicates that neither of these provision was ever applied to punish an alleged violation of section 204. S e c t i o n1 2 8 4o f E P A c t 2 0 0 5e x p a n d e dt h eC o m m i s s i o n s a u t h o r i t yu nder FPA section 316A to enforce civil penalties for violations of any section of Part II of the FPA, including section 204. See EPAct 2005. 1284(e)(1), Pub. L. No. 109-58, 119 Stat. at 980 (amending 16 U.S.C.
47
89
clear, however, exactly how the Commission would apply this authority if a public utility failed to obtain section 204 approval before issuing a security or assuming debt. For example, it is not clear whether the Commission would regard that as a single violation or assess penalties for each day that elapsed between the date of an illegal issuance or assumption and the date of corrective action.48 Regardless of the exact formulation, the C o m m i s s i o n si n c r e a s e dp e n a la u t h o r i t yb r i n g san e wu r g e n c yt ot h ed e v e l o p m ent or 49 maintenance of a strong section 204 compliance program. Compliance with FPA section 204 requirements can be evaluated in a two-part process, consisting of a snapshot evaluation of current compliance and a going forward assessment of the program for continued compliance. For many public utilities subject to section 204, both the snapshot evaluation and the going forward evaluation should be a simple matter of confirming either that: (a) the Commission lacks jurisdiction over the issuance or assumption50 or (b) the public utility has current prior blanket authorization to issue securities or assume liabilities. 51 In such cases, there should be no current compliance issues, and the only going forward issue would be to ensure that existing authorizations remain sufficient in particular, by establishing a system to require a check on section 204 issues any time a market-based rate application or amendment is filed or a new public utility affiliate is formed or acquired. For those companies that are subject to the broader requirements under FPA section 204, a more detailed approach is appropriate. First, for each public utility, a list could be created of all issuances of securities or assumptions of liabilities for which there was no applicable prior blanket authorization. The issuances and assumptions on those lists could then be checked against Commission authorizations, bearing in mind that any issuance of securities must be specifically tailored to the timing, type of issuance and purposes expressly authorized by the Commission in each authorization order and that any issuances of secured or non-secured debt that occurred after February 21, 2003 must comply with the Westar requirements set forth above. Current compliance could then be assessed by checking any issuances or assumptions that are on the lists but have not been the subject of Commission authorizations against the parameters established by the Commission to determine whether authorization should have been sought.
825o-1(a)). In addition, potential penalties were also increased from $10,000 to $1,000,000 per day for each violation. See id. 1284(e)(2) (amending 16 U.S.C. 825o-1(b)). The Commission has recently issued a policy statement explaining the factors it will rely upon in assessing penalties under the new statute. See Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 1 1 3 F E R C 6 1 , 0 6 8 ( 2 0 0 5 ) ( Enforcement Policy Statement ) . A detailed discussion of this new authority and the Enforcement Policy Statement is found in Chapter 3 of this Handbook. See Enforcement Policy Statement, 113 FERC 61,068 at P 13 (stating that the C o m m i s s i o n w i l l n o t p r e s c r i b e s p e c i f i c p e n a l t i e s o r d e v e l o p f o r m u l a s f o r d i f f e r e n t v i o l a t i o n s ) . See id. a t P2 2 ( l i s t i n g f a c t o r s that will be taken into account in determining credit given f o r a c o m p a n y s c o m m i t m e n t t o c o m p l i a n c e ) .
49 50 51 48
16 U.S.C. 824c(f).
See supra Part II.B. A company may wish to determine whether any issuance or assumption occurred before the prior blanket authorization took effect.
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Going forward compliance depends in the first instance on development of a system to alert compliance personnel of any prospective issuance of securities or assumptions of liabilities by a public utility. Rather than allow others in the company to determine what companies in the corporate family are public utilities, compliance personnel should develop and regularly update a list of public utilities for use in this process. Once this system is in place, the first step in evaluating a prospective issuance or assumption would be to determine whether it is authorized under any previously received authorization still in effect on the date of the assumption or issuance, again bearing in mind that any issuance of securities must be specifically tailored to the timing, type of issuance and purposes expressly authorized by the Commission and that all issuances of secured and nonsecured debt must comply with the Westar requirements set forth above. If there is no prior authorization for a prospective issuance or assumption, the next step would be to determine whether Commission authorization is necessary and, if so, to seek it. As noted above, however, determining when FERC authorization is required can be difficult. In the event of uncertainty as to whether FERC authorization is required, a company could voluntarily submit to FERC jurisdiction, request a disclaimer of jurisdiction or seek informal staff advice i nt h ef o r mo f a n oa c t i o n letter. An additional option would be to take an aggressive approach and proceed with the issuance or assumption without Commission authorization or a Commission determination that authorization is not necessary. However, with the substantial increase i nF E R C s penal authority under EPAct 2005 and FERC s Enforcement Policy Statement, the risks of such a course of action have increased significantly.
Chapter 7 Power Sales and Related Jurisdictional Transactions

JOHN N. ESTES III KATHRYN KAVANAGH BARAN INTRODUCTION The he a r t o f t h e F e d e r a l P o w e r A c t ( FPA ) is the jurisdiction it grants to the Federal E n e r g y R e g u l a t o r y C o m m i s s i o n ( F E R C o r C o m m i s s i o n ) to regulate the rates, terms and conditions of jurisdictional sales of energy and transmission. This chapter addresses the power sales element of FERC s domain. A number of important compliance issues are presented by FPA section 205, which as a general rule requires jurisdictional agreements to be filed with the Commission before they take effect. In this chapter, we address the standards governing which agreements are jurisdictiona l a n do f t h o s e , w h i c hm u s t b e o n f i l e with the Commission. We also explain when the agreements must be filed and the standards for obtaining a waiver of the prior notice requirement. Transaction-specific criteria, such as those relating to market-based power sales, cost-based power sales, ancillary services sales, and sales to affiliates, are explained, as well as the potential penalties and remedies for failure to comply with applicable requirements. I. A. GENERAL Section 201 of the Federal Power Act grants FERC jurisdiction over wholesale sales 2 of energy. 1 T h es e r v i c e sm u s t b ep r o v i d e db ya p u b l i cu t i l i t y t ob ej u r i s d i c t i o n a l . A p u b l i c u t i l i t y i s a n yp e r s o nw h oo w n s o r o p e r a t e s f a c i l i t i e s u s e df o r w h o l e s a l es a l e s o r 3 transmission of electric energy in interstate commerce. Section 205(a) provides the C o m m i s s i o nw i t hj u r i s d i c t i o nt oe n s u r et h a t [ a ] l l rates and charges made, demanded, or received by any public utility for or in connection with the transmission or sale of electric energy subject to the jurisdiction of the Commission, and all rules and regulations affecting SCOPE OF FERC JURISDICTION
Partner, Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Estes focuses on complex FERC litigation and appellate matters involving restructured electric markets, and has played a lead role in several of the most significant cases in this area.
1 2 3
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. 16 U.S.C. 824 (2000). Id. 824(b)(1). Id. 824(e).
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4 or pertaining to such rates or charges s h a l l b e j u s t a n d r e a s o n a b l e . Section 205(c), in turn, s e t s f o r t h t h e C o m m i s s i o n s j u r i s d i c t i o n t or e q u i r e t h e filing of contracts, even those that do not provide for the sale of wholesale power or transmission service. It provides that the C o m m i s s i o nm a yr e q u i r et h ef i l i n go f a l l r a t e sa n dc h a r g e sf o r a n yt r a n s m i s s i o no r s a l e subject to the jurisdiction of the Commission, and . . . all contracts which in any manner 5 affect or relate to such r a t e s , c h a r g e s , c l a s s i f i c a t i o n s , a n d s e r v i c e s .
B. SPECIFIC TYPES OF JURISDICTIONAL AGREEMENTS A contract or tariff that sets forth the rates, terms or conditions for the sale of power at wholesale by a public utility is jurisdictional. 6 The same is true for an agreement that allocates wholesale power or transmission costs.7 Certain contracts, however, have a less certain jurisdictional status. If a contract does not provide for the sale of transmission capacity or wholesale power, the question ordinarily becomes whether it nonetheless contains 8 r u l e sa n dr e g u l a t i o n sa f f e c t i n go r p e r t a i n i n gt o j u r i s d i c t i o n a l r a t e s . Of necessity, this question can be answered only on a case-by-case basis. That said, there is a common thread that runs through many of th e c a s e s , w h i c h i s t h e q u e s t i o n o f c o n t r o l : whether the provider o f a s e r v i c e g a i n s , t h r o u g h t h e a g r e e m e n t i n q u e s t i o n , e f f e c t i v e c o n t r o l o v e r a j u r i s d i c t i o n a l facility, service or rate. A few examples help to illustrate this test. The first is an o p e r a t i o n a n d m a i n t e n a n c e ( O & M ) c o n t r a c t .A n O & Mc o n t r a c t i s said to be jurisdictional if the operator exercises effective control over the facilities at issue (and, of course, is a public utility as well).9 The essence of the control test is whether the operator needs approval from the owner of the facility for non-routine or major actions.10 If it does, then control is not deemed to have been conferred on the operator. If, however, the o p e r a t o r s a u t h o r i t y i s c o n s t r a i n e d o n l yb y a g o o d u t i l i t y p r a c t i c e s t a n d a r d , o r t h e o p e r a t o r o t h e r w i s eh a s f u l l d i s c r e t i o n a r ya u t h o r i t y , i t i sd e e m e dt oh a v eb e e n d e l e g a t e [ d ]. . .
4 5 6 7 8 9
Id. 824d(a) (emphasis added). Id. 824d(c) (emphasis added). Nantahala Power & Light Co. v. Thornburg, 476 U.S. 953, 965 (1986). Id. 16 U.S.C. 824d(a).
See Prior Notice and Filing Requirements Under Part II of the Federal Power Act , 64 FERC 61,139, at 61,993-94, o r d e r o n r e h g , 6 5 F E R C 6 1 , 0 8 1 ( 1 9 9 3 ) ( Prior Notice ). T h ep a r t yt h a t o p e r a t e s i st h e e n t i t y[ t h a t ]k e e p sc o n t r o la n d[ m a i n t a i n s ] d e c i s i o n m a k i n g a u t h o r i t y o v e r m a j o r m a t t e r s . Puget Sound Power & Light Co., 64 FERC 61,335, at 63,427 (1993); see also, e.g., James River Paper Co., Inc., 73 FERC 61,025, at 61,058-59 (1995) ( f i n d i n gt h a t p e t i t i o n e rd i dn o t o p e r a t e f a c i l i t i e sb e c a u s e( a )i t sa c t i v i t i e sw o u l db es u b j e c t t o approval, (b) it would not have full operational responsibility for the facility, (c) it would not be responsible for energy sales, billing and collections, operating budget and payment of fees and expenses, and (d) it did not have final authority over all operating decisions); Ogden Martin Sys. of Clark Ltd., P'ship., 66 FERC 61,152, at 61,295 (1994) (determining that the entity with the power to m a k e a l l s i g n i f i c a n t d e c i s i o n s a n d t o a p p r o v e a na g e n t s a c t i o n s i s t h e o p e r a t o r , a n do n e i s n o t t h e o p e r a t o r i f i t s r e s p o n s i b i l i t i e s a r e s u b j e c t t o d i r e ction and approval of another).
10
POWER SALES AND RELATED JURISDICTIONAL TRANSACTIONS
93
c o n t r o l a n dd e c i s i o n m a k i n g a u t h o r i t ya n dthus to be providing a jurisdictional service.11 This test applies to generating facilities e v e nt h o u g ht h e ya r en o t j u r i s d i c t i o n a l f a c i l i t i e s , presumably because the operator c a ne x e r t c o n t r o l o v e r w h o l e s a l e p o w e r s a l e s t h r o u g hi t s control over the generating station itself. A similar analysis applies to a wide range of services provided under so-called energy management agreements that are increasingly c o m m o ni nt o d a y s m a r k e t s .I nEl 12 Paso Electric Company the Commission held that Enron Power Marketing, Inc. had a s s u m e d c o n t r o l o v e r c e r t a i n j u r i s d i c t i o n a l p o w e r s a l e s m a d e b y E l P a s o Electric Company b e c a u s e E l P a s oE l e c t r i c a d m i t t e d t h a t i t g a v e E n r o n d i s c r e t i o n o n h o w , w h e n , a n d t o w h o m i t c o u l ds e l l p o w e r o n E l P a s oE l e c t r i c s b e h a l f w h i l e E n r o n r a n t h e E l P a s oE l e c t r i c t r a d i n g 13 d e s k . A similar result was reached in R.W. Beck Plant Management, Ltd.14 In that case, the Commission held that the manager of a power plant (and appurtenant jurisdictional facilities) w a s ap u b l i cu t i l i t yb e c a u s e e x c e p t f o r c e r t a i np o w e r s r e s e r v e dt ot h e[ o w n e r ] , B e c kh a s complete authority to manage, control and make all decisions affecting the business and a f f a i r so f [ t h ep l a n t ] a n d , f u r t h e r m o r e , t h eo w n e rh a d n oe m p l o y e e sa n dn oc o m p a n y 15 p e r s o n n e l r e s p o n s i b l ef o r m a n a g e m e n t o f t h e[ p l a n t ] . Beck thus was deemed to be the operator of the jurisdictional facilities and was required to file for market based rate authority.16 A n o t h e r l i n eo f c o n t r o l c a s e s i n v o l v e s power exchanges. 17 The Commission has e x e r c i s e dj u r i s d i c t i o n o v e r p o w e r e x c h a n g e s i f t h e y e x e r t a c t i v e c o n t r o l o v e r j u r i s d i c t i o n a l
Puget Sound, 64 FERC 61,335, at 63,426; see also PSI Energy, Inc., 63 FERC 6 1 , 1 0 7 , a t 6 1 , 7 5 3( 1 9 9 3 ) ( f i n d i n gj u r i s d i c t i o nw h e r e o p e r a t o r c o n s t r a i n e do n l yb y p r u d e n t u t i l i t y p r a c t i c e ) ; Western Mass. Elec. Co., 61 FERC 61,182, at 61,664 (1992) (finding jurisdiction where o p e r a t o rh a d f u l l d i s c r e t i o n a r ya u t h o r i t yt oc o n d u c t a n yn e c e s s a r yO & Mw o r k ) ; Duke Energy Corp., 97 FERC 61,177, at 61,823-24 (2001) (disclaiming jurisdiction over agreements) (citing Bechtel Power Corp., 60 FERC 61,156 (1992)); Long Island Lighting Co., 67 FERC 61,361, at 62,254 (1994) (stating that an agreement to provide O&M services need not be filed with the C o m m i s s i o n i f t h e e n t i t y p e r f o r m i n g t h e O & Ms e r v i c e u n d e r t h e a g r e e m e n t a c t s m e rely as the agent of another party wielding authority to make main operational decisions . . . even if [the O&M service provider] is a public utility ) ( e m p h a s i s a d d e d ) .
12 13 14 15 16 17
11
108 FERC 61,071, at P 14 (2004). Id. at P 14. 109 FERC 61,315 (2004). Id. at PP 3, 12. Id. at P 15.
I t s h o u l d b e n o t e d t h a t t h e p o w e r e x c h a n g e c a s e s u s e c o n t r o l a s a d e t e r m i n a n t o f b o t h (i) whether the exchange itself is a public utility and (ii) whether the service it provides is jurisdictional.
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transactions or facilities. 18 T h e yk e ye l e m e n t s o f c o n t r o l h a v ei n c l u d e ds e t t i n g t h em a r k e t 19 p r i c ea t w h i c he n e r g yw i l l b es o l d , a n da f f e c t i n g u n i t c o m m i t m e n t a n ds c h e d u l i n g decisions.20 By contrast, a power exchange that acts as a bulletin board or brokering service is not deemed to have control and thus is not deemed jurisdictional. 21 Although the full extent of jurisdictional agreements that relate to the sale of power or operation of generating facilities cannot be discussed here in detail, the following are among the types of agreements that have been found to be jurisdictional under certain circumstances in the past: P o w e r C o n s u l t i n g S e r v i c e s A g r e e m e n t s ( P S C A ) ,22 O p e r a t i o n s &Ma i n t e n a n c e ( O & M ) A g r e e m e n t s ,23 C o n t r i b u t i o n s I n A i d o f C o n s t r u c t i o n ( C I A C ) Agreements, and24 Unit Contingent or Tolling Agreements.25 C. THE REQUIREMENT TO F ILE CERTAIN AGREEMENTS - THE RULE OF REASON TEST Section 205 also confers jurisdiction on FERC to require a utility to file any contract t h a t i n a n y m a n n e r a f f e c t [ s ] o r r e l a t e [s] to [jurisdictional] rates, charges, classifications, and 26 s e r v i c e s . T h e c o u r t s h a v ec h a r a c t e r i z e dt h i s a s a n a m o r p h o u s d i r e c t i v e a n dh a v eh e l d t h a t o n l y t h o s e p r a c t i c e s t h a t a f f e c t r a t e s a n d s e r v i c e significantly c a n b e s a i d t of a l l w i t h i n 27 28 it. T h e C o m m i s s i o n h a s a p p l i e d t h i s s t a n d a r d u s i n g w h a t i t c a l l s a r u l e o f r e a s o n t e s t .
Automated Power Exch., Inc., 8 2F E R C 6 1 , 2 8 7 , a t 6 2 , 1 0 8( 1 9 9 8 )( APX ) , a f f d , Automated Power Exch., Inc. v. FERC, 204 F.3d 1144 (D.C. Cir. 2000).
18 19 20 21 22 23
APX, 82 FERC 61,287, at 62,108. Pacific Gas & Elec. Co., 77 FERC 61,204, at 61,805 (1996). See Continental Power Exch., Inc., 68 FERC 61,235, at 62,105 (1994). See El Paso Elec. Co., 108 FERC 61,071 at P 19.
See Illinois Power Co., 102 FERC 61,184, at 61,506 (2003); ITC Holdings Corp., 102 FERC 61,182, at 61,488 (2003). See, e.g., Southern Cal. Edison Co., 98 FERC 61,304, at 62,301 (2002); American Elec. Power Serv. Corp., 96 FERC 61,136, at 61,570 (2001); accord American Elec. Power Serv. Corp., 95 FERC 61,012, at 61,019-20 (2001); Prior Notice, 64 FERC 61,139 at 61,981-82, 61,989-91.
25 26 27 28 24
See, e.g., AES Huntington Beach, L.L.C., 87 FERC 61,221, at 61,877 (1999). 16 U.S.C. 824d(c). Cleveland v. FERC, 773 F.2d 1368, 1376 (D.C. Cir. 1985) (emphasis in original).
See P u b l i c S e r v . C o m m no f N . Y . v . F E R C , 813 F.2d 448, 454 (D.C. Cir. 1987) (holding that the Commission properly excused utilities from filing policies or practices that dealt only with m a t t e r so f p r a c t i c a li n s i g n i f i c a n c e t os e r v i n gc u s t o m e r s ) ;Midwest Indep. Transmission Sys.
95
This rule of reason test is, of necessity, fact-specific. There are many cases that apply the test, but the following two are particularly illustrative because they compare and contrast practices that do and do not need to be filed. In the first, Easton v. Delmarva Power & Light Co.,29 t h e C o m m i s s i o n r u l e d t h a t t h e m i n u t e d e t a i l e d o p e r a t i n g p r o c e d u r e s o f a p o w e r p o o l 30 n e e dn o t b e f i l e d , b u t t h a t r e q u i r e m e n t s f o r o b t a i n i n g t r a n s m i s s i o n c a p a c i t y m u s t b e f i l e d . In the second, PacifiCorp,31 the Commission held that regional reliability council documents t h a t m e r e l y r e c o m m e n d o p e r a t i n gp r o c e d u r e sn e e dn o t b ef i l e d , b u t t h o s et h a t d i c t a t e transmission procedures must be filed. 32 Today, the rule of reason test most often arises with respect to protocols or operating procedures used by an RTO. For instance, the Commission has held that while the Business P r a c t i c e s Ma n u a l s o f t h e Mi d w e s t I S Oi m p l i c a t e t h e C o m m i s s i o n s j u r i s diction because they g e n e r a l l yi n v o l v e t h ei n s t a l l a t i o n , o p e r a t i o n , o ru s eo f f a c i l i t i e sf o rt h et r a n s m i s s i o no r delivery of power . . . i ni n t e r s t a t ec o m m e r c e , t h e ydo not require a section 205 filing 33 b e c a u s e t h e y m o s t l y i n v o l v e g e n e r a l o p e r a t i n g p r o c e d u r e s . However, such manuals must be available for public inspection on a permanent basis (such as being posted on the RTO website). It should also be noted that whether or not a particular contract or tariff is subject to a s e p a r a t e f i l i n g r e q u i r e m ent, any jurisdictional agreements and sales made under the contract or tariff may be s u b j e c t t ot h eC o m m i s s i o n s e l e c t r o n i cr e p o r t i n gs y s t e m .T h e s e reporting obligations are discussed separately under Electronic Quarterly Reports (EQRs) in Chapter 4. D. COMPLIANCE WHERE THERE IS AMBIGUITY Recognizing that uncertainty will arise about the status of specific agreements, the Commission has held that when in doubt, a utility may file its agreements and request that the Commission make a determination as to whether they are jurisdictional and/or must be kept on file. For example, in Montana-Dakota Utilities Co.,34 F E R Ch e l d t h a t a n y u t i l i t y , i f uncertain as to its obligation under the FPA to file for Commission review or as to the jurisdictional status of a particular agreement, should take the initiative to seek case-specific
Operator, Inc., 98 FERC 61,137, at 61,401( 2 0 0 2 )( I ta p p e a r st h a t t h ep r o p o s e dO p e r a t i n g Protocols could significantly affect certain rates and service and as such are required to be filed p u r s u a n t t o S e c t i o n 2 0 5 . ) .
29 30 31 32 33
24 FERC 61,251, at 61,531-32 (1983). Id. at 61,531. 70 FERC 61,322 (1995). Id. at 61,984-85.
Midwest Indep. Transmission Sys. Operator, Inc., 108 FERC 61,163, at P 658 (2004); see also PJM Interconnection, L.L.C., 81 FERC 61,257, at 62,267 (1997) (finding no reason to require filing of the PJM Manuals).
34
81 FERC 61,298 (1997).
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35 g u i d a n c ef r o mt h eC o m m i s s i o ni na d v a n c eo f t h ee f f e c t u a t i o no f j u r i s d i c t i o n a l s e r v i c e . 36 Other cases similarly support the no t i o no f w h e ni nd o u b t , f i l e . Given this guidance, FERC is less likely to consider arguments that remedies (such as time value refunds) should not be imposed for the failure to file a particular agreement due to uncertainty regarding whether that agreement was jurisdictional. FERC is also generally unreceptive to arguments r e l a t e dt o a d m i n i s t r a t i v eb u r d e n s a sar e a s o nf o rn o t f i l i n gap o t e n t i a l l yj u r i s d i c t i o n a l 37 agreement.
E. COMPLIANCE RECOMMENDATIONS T h e b r e a d t h o f F E R C s j u r i s d i c t i o n t o a p p r o v e , o r r e q u i r e t h e f i l i n g o f , p o w e r -related agreements means that companies should have internal processes for identifying contractual arrangements and operating protocols that could require a FERC filing. This review should occur at the time the agreement is being negotiated because, as explained below, jurisdictional agreements must ordinarily be filed before they take effect. Furthermore, if legal review is obtained at the time an agreement is being negotiated, modest changes to the agreement (such as reductions in the level of control) may avoid the need for FERC approval. These internal processes should be developed not only by public utilities but also other companies that provide energy management services. The R.W. Beck decision shows that even a consulting firm can be deemed a public utility providing jurisdictional services under certain circumstances. II. A. GENERAL The FPA contains a prior notice requirement for approval of jurisdictional contracts, namely that the Commission and the public be given sixty (60) days notice of any change in rate, service or term before it takes effect.38 F E R C s r u l e s a l s os p e c i f yt h a t t h e p r i o r n o t i c e requirements apply to cancellation or termination of a rate schedule or part thereof.39 As a
35 36
PRIOR NOTICE AND FILING REQUIREMENTS
Id. at 62,407 (citing Prior Notice, 64 FERC 61,139, at 61,977-78, 61,985).
See, e.g., Public Serv. Co. of Colo., 67 FERC 61,371, at 62,267-68 (1994) (refusing to d i s c l a i mj u r i s d i c t i o no v e r1 8a g r e e m e n t sa n ds t a t i n gt h a t [ f ] r o mt h eC o m m i s s i o n sp e r s p e c t i v e , [public utilities should] file all agreements under which they are providing service that possibly can b e c o n s i d e r e d j u r i s d i c t i o n a l ) .
37 38
See, e.g., Idaho Power Co., 102 FERC 61,351, at P 26 (2003).
16 U.S.C. 824d( d ) .T h i s r u l e d o e s n o t a p p l y t o a n i n i t i a l r a t e , b u t F E R Ch a s d e f i n e d i n i t i a l r a t e v e r y n a r r o w l y a n d h e n c e v i r t u a l l y e v e r y n e wc o n t r a c t o r t a r i f f w i l l c o n s t i t u t e a c h a n g e i n rate and will therefore be subject to a prior notice requirement, as well as the potential for suspension of the rate and refunds. Middle South Energy, Inc. v. FERC, 747 F.2d 763, 772 (D.C. Cir. 1984). As a general rule, an initial rate must involve both a new service and a new customer. Chehalis Power Generating, L.P., 112 FERC 61,144, at P 23 (2005). Companies must file notification of cancellation or termination no less than sixty (60) days and no more than one-hundred twenty (120) days prior to the expiration of an existing contract or service agreement for all sales of unbundled transmission service and for all power sales contracts executed or filed prior to July 9, 1996, and for power sales contracts executed after that date that do
39
97
general rule, a filing to change or cancel a rate schedule must be submitted at least sixty (60) days, but not more than one-hundred twenty (120) days, prior to the date it is proposed to take effect.40 FERC typically acts on section 205 filings within the 60-day statutory period.41 FERC action within the statutory period varies depending on the circumstances, as described below: If all affected parties agree to the filing, FERC ordinarily will accept the agreement without suspension or hearing. If a customer or other affected party protests the filing, FERC may accept the agreement, suspend it, and set the matter for hearing. Hearings are required only w h e r e m a t e r i a l i s s u e s o f f a c t e x i s t a n da r e m o s t l i k e l y o r d e r e di n c o n t e s t e d r a t e proceedings or where the parties disagree over the interpretation of an agreement. Where only policy or legal issues are presented, or where factual issues can be decided on the existing paper record, FERC may rule summarily on any disputed issues within the 60-day period and not order any further proceedings. If the utility has not submitted sufficient information (such as cost support) to m e r i t a p p r o v a l o f i t s f i l i n g , F E R CS t a f f m a y i s s u e a d e f i c i e n c y l e t t e r r e q u e s t i n g that more information be submitted within 30 days. The response to such a letter is considered an amendment to the filing, subject to a new notice and comment period. Thus, the issuance of such a letter tolls the time for FERC action on the f i l i n ga n d an e w 6 0 -d a yc l o c k c o m m e n c e sw h e nt h eu t i l i t ya m e n d si t s application with the new information. Staff may also contact applicants informally (typically by telephone) and request additional information, which also m a y b e d e e m e d a n a m e n d e d f i l i n g , triggering a new 60-day clock. In rare cases, FERC will reject the filing summarily. 42 This can occur, for example, where the utility has failed to follow the requirements for rate increases
not terminate by their own terms. For any power sales contract executed or filed on or after July 9, 1996 that terminates by its own terms, a notice of termination must be filed within thirty (30) days after such termination takes place. See 18 C.F.R. 35.15 (2005). See id.F E R C s r u l e s a l s o s p e c i f y t h a t n o t i c e o f a s u c c e s s o r i ni n terest or name changes of the tariff holder be filed within thirty (30) days of such change. See id. 35.16.
40
There are circumstances in which FERC does not always act within the 60-day period, including (1) when a section 205 issue is raised in the same filing as a request for approval of a transaction subject to section 203; (2) when a filing is made in compliance with a Commission order; and (3) if a filing is made more than 120 days before the requested effective date. The legal standard is that F E R Cr e j e c t i o n i s a p p r o p r i a t e i f t h e f i l i n g i s a p a t e n t n u l l i t y . See Municipal Light Boards of Reading and Wakefield, Mass. v. FPC, 450 F.2d 1341, 1345 (D.C. Cir. 1971) (finding rejection appropriate if a filing is patently . . . deficient in form or a substantive nullity ); see also Kentucky Utils. Co., 67 FERC 61,189, at 61,575 (1994); Pennsylvania Power & Light Co., 23 FERC 61,215, at 61,446 (1983).
42
41
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK in section 35.13 or has not complied with a Mobile Sierra43 clause that restricts unilateral rate changes.
B. WAIVER OF THE PRIOR NOTICE REQUIREMENT The Commission may waive the 60-day prior notice requirement if the filing party 44 c a n d e m o n s t r a t e g o o d c a u s e . For example, the Commission generally will grant waivers for filings that increase rates if the rate change and effective date are prescribed by contract, such as annual rate revisions required by contract to become effective on a date specified in the contract.45 The Commission also may waive the prior notice requirements where the 46 p r o p o s e df i l i n g w i l l n o t p r o d u c eu n r e a s o n a b l er e s u l t s . That said, waiver of the prior notice requirement is not always easily obtained, particularly if the proposed rate involves an increased charge to customers.47 FERC rarely has granted waiver of its notice and filing requirements to allow a rate schedule to go into effect retroactively. 48 It may impose remedies for commencing any type of jurisdictional service without the required filing. (See penalty section below.) Waivers of notice may even be more difficult to obtain under Chairman Kelliher, who has dissented from at least one Commission order that granted a waiver of notice.49 C. NOTICE REQUIREMENTS FOR SPECIFIC TYPES OF AGREEMENTS The prior discussion provided the general rules for providing prior notice and waivers respecting such notice. These rules vary somewhat, however, as applied to particular transactions. For example, in some situations, FERC does not require the filing of an agreement before it takes effect. This situation most commonly arises for service agreements e n t e r e di n t ou n d e r t a r i f f s o fg e n e r a l a p p l i c a b i l i t y .F o re x a m p l e, if a utility receives approval of a general tariff to sell power to any wholesale customer at negotiated, transaction-specific rates (whether market-based rates or cost-b a s e dr a t e s u pt o ac e i l i n g rate), the agreements (often c o n f i r m a t i o nl e t t e r s ) a ssociated with particular transactions
See United Gas Pipeline Co. v. Mobile Gas Service Corp, 350 U.S. 332 (1956); Federal P o w e r C o m m n . v . S i e r r a P a c . P o w e r C o ., 350 U.S. 348 (1956). Central Hudson Gas & Elec. Corp., 60 FERC 61,106, at 61,338-39, o r d e r o n r e h g , 61 F E R C 6 1 , 0 8 9 ( 1 9 9 2 ) ( Central Hudson ) .
44 45 46 47
43
CalPeak Power, LLC, 110 FERC 61,145, at P 11 (2005) (citing cases). PJM Interconnection, L.L.C., 109 FERC 61,379, at P 5 (2004) (citing cases).
Old Dominion Elec. Coop., 110 FERC 61,165, at P 7 (2005) (denying request for waiver because proposal to modify the classification of certain accounts from demand to energy will result in some customers experiencing an increase in rates); see also Pacific Gas & Elec. Co., 109 FERC 61,093, at PP 22-30 (2004).
48
See Mirant Americas Energy Mktg., L.P. v. ISO New England, Inc., 112 FERC 61,056 See, e.g., ISO New England, Inc., 112 FERC 61,057 (2005).
(2005).
49
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entered into pursuant to that tariff do not need to be filed with FERC.50 As noted, however, t r a n s a c t i o n s u n d e r s u c h a g r e e m e n t s a r e s t i l l s u b j e c t t o t h e C o m m i s s i o n s E Q Rr e q u i r e m e n t s . Public utilities may file standard forms of service agreements for Commission approval for all of their jurisdictional cost-based transmission and power sales services. Public utilities that have Commission-approved standard forms of agreements in their transmission, cost-based power sales tariffs, or tariffs for other generally applicable services are not required to file hard copies of conforming agreements with the Commission.51 However, individual agreements for transmission or interconnection services, cost-based power sales, and other generally applicable services that do not conform to an applicable standard form agreement, such as agreements containing customized terms and conditions or unexecuted agreements for any service, must be filed with the Commission for prior approval.52 D. COMPLIANCE RECOMMENDATION Companies should establish processes to permit the preparation of any required FERC filing before a jurisdictional agreement takes effect (unless, as indicated, no filing is required). In many cases, the preparation of a FERC filing does not take significant lead time and, indeed, can be completed in a few days. In other situations, however, far more lead time is required. A request for market-based rates requires that the applicant perform the two market power screens discussed in Section III.A.1 below, which is a time consuming effort. An affiliate agreement will require the applicant to meet the Boston Edgar test described in section III.C below, which also can be very time consuming to prepare. Finally, a rate increase to a customer that is likely to protest such increase could require a full cost of service under section 35.13, which ordinarily takes months to prepare. III. RULES APPLICABLE TO PARTICULAR TYPES OF POWER TRANSACTIONS This section briefly describes the substantive requirements applicable to certain types of power sales, including market-based rates, cost-based rates and affiliate transactions. We do not provide an exhaustive discussion of the case law, but rather identify the relevant tests and standards to enable company counsel to determine the general requirements applicable to a given transaction. In addition, we also discuss reporting requirements that apply to marketbased transactions, which present important and difficult compliance issues.
See City of Santa Clara v. Enron Power Mktg., Inc., 110 FERC 61,281, at PP 28-29 & P2 9n . 2 5( 2 0 0 5 ) ( e x p l a i n i n gt h eC o m m i s s i o n sp o l i c yd o e sn o t r e q u i r et h ef i l i n go f subsequent agreements or confirmation letters for individual transactions). Revised Public Utility Filing Requirements, Order No. 2001, 67 Fed. Reg. 31,043 (Apr. 25, 2002), III FERC Stats. & Regs., Regs. Preambles 3 1 , 1 2 7 , a t P 1 8( O r d e r N o . 2 0 0 1 ) , reh g denied, Order No. 2001-A, 100 FERC 61,074 (2002).
52 51
50
Id. at P 19.
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A. MARKET-BASED RATES 1. Standards for Approval FERC may authorize market-based rates where it determines that sufficient competition exist to ensure that market-based rates are just and reasonable.53 Although the Commission has, in Order No. 2001,54 waived the requirement to file conforming power sales agreements for sellers with market-based rate authority, such sellers must notify the Commission of changes in status that reflect a departure from the characteristics the Commission has relied upon in approving market-based pricing. 55 The test used to determine whether market-based pricing should be authorized has evolved significantly over the past decade and continues to change as FERC gains more experience with competitive markets. This section describes the current test for receiving market-based rates, including the interim generation market power test that was adopted in April 2004,56 although we note that FERC has a pending rulemaking in which it may adopt changes to that market power test.57 F E R C s m a r k e t p o w e r t e s t c o n t a i ns four prongs: (i) control of transmission, (ii) generation market concentration, (iii) affiliate issues and (iv) barriers to entry, each of which is discussed briefly below. Transmission. FERC requires that a seller of power and its affiliates that own transmission facilities provide open, nondiscriminatory access to those facilities as a condition of granting market-based rate approval.58 This test generally is satisfied if the transmission owner has filed a pro forma, open access transmission tariff ( OATT ) in accordance with Order No. 888. However, in situations where customers have alleged that the utility has discriminated against its competitors despite the presence of an OATT, such allegations may be set for hearing as part of FERC's determination of the relevant geographic market for purposes of its generation market power analyses.59 If the utility is an RTO participant, transmission market power is unlikely to be a concern. Generation. FERC uses two i n d i c a t i v e m a r k e tp o w e r s c r e e n s t od e t e rmine whether the applicant may be a dominant seller of generation in the area for which marketbased rate authority is sought.60 T h ef i r s t i s c a l l e dt h e p i v o t a l s u p p l i e r t e s t a n ds e e k s t o
See Elizabethtown Gas Co. v. FERC, 10 F.3d 866, 870-71 (D.C. Cir. 1993); Public Util. Dist. No. 1 of Snohomish County v. Dynegy Power Mktg., Inc. , 384 F.3d 756, 760-61 (9th Cir. 2004).
54 55 56 53
Order No. 2001, III FERC Stats. & Regs., Regs. Preambles 31,127 See infra section III.A.3 (discussing change in status filings).
AEP Power Mktg., Inc., 1 0 7F E R C 6 1 , 0 1 8( AEP I ) , o r d e ro nr e h g , 108 FERC 6 1 , 0 2 6 ( 2 0 0 4 ) ( AEP II ) . See Market-Based Rates for Public Utilities, Initiation of Rulemaking Proceeding on Market-Based Rates and Notice of Technical Conference, 107 FERC 61,019 (2004).
58 59 60 57
See Southern Co. Servs., Inc., 71 FERC 61,392, at 62,536 (1995). See Entergy Servs., Inc., 111 FERC 61,507, at P 25 (2005). AEP I, 107 FERC 61,018 at P 36.
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determine whether, if the applicant's capacity were removed from the market, there would be adequate capacity from alternative sellers to satisfy demand. The second is called the w h o l e s a l e m a r k e t s h a r e s c r e e n a n ds e e k s t od e t e r m i n e w h e t h e r t h e a p p l i c a n t h a s a 2 0 %o r greater market share. In each instance, these screens are applied to individual g e o g r a p h i c markets based on control areas,61 such that the failure of a screen in one market would not deprive the applicant of authority to sell at market-based rates in other markets. If the applicant fails either screen62 in any market, it c r e a t e sa r e b u t t a b l e p r e s u m p t i o n o f m a r k e t p o w e r , leaving several options. First, the applicant can withdraw its request for market-based rates in the area in question and sell at cost-based rates instead. If it chooses this option, the a p p l i c a n t c a n u s e t h e d e f a u l t c o s t -based rates set forth in the AEP I order or it can seek approval of alternative forms of c u s t o m i z e d cost-based rates. The a p p l i c a n t s s e c o n d o p t i o n i s t o c o n t i n u e t o p u r s u e m a r k e t -based rate authority by presenting a more comprehensive set of market power measures computed using t h e D e l i v e r e dP r i c e T e s t ( D P T ) d e s c r i b e di nF E R C s r e g u l a t i o n sf o r section 203 applications.63 The DPT provides a more detailed analysis of the relevant markets, stratifying them by price level and using complex modeling tools to calculate market shares and concentration ratios. If the applicant also fails the DPT-based screens, it has the option of using other evidence (such as historical sales) to rebut the presumption of market power. Efforts to rebut the market power presumption resulting from failure of the indicative screens have been mixed. For example, Duke Power s attempt was unsuccessful because its analysis reflected screen failures in the DPT-based analysis, while Kansas City Power & Light Company was able to show that there were no material screen failures when capacity dedicated to serving native load was factored into the DPT results.64 Affiliate Issues. FERC considers whether affiliate dealings provide a basis for denying or conditioning the request for market-based rate authority. Such concerns arise when the applicant or its affiliate(s) have captive ratepayers that could be harmed by abusive affiliate dealings. 65 In most cases, the affiliate issue can be satisfied by (1) adopting a tariff provision restricting affiliate sales (or permitting such sales under certain conditions see the discussion in section III.C of this chapter) and (2) filing of a Code of Conduct that, among other things, restricts exchanges of market information between a franchised utility and its power marketing affiliate.66 In one recent case, however, FERC set for hearing certain
While the Commission no longer automatically grants market-based rate authority for s a l e sm a d ew i t h i na na p p r o v e dR T O ,i ta l l o w sa p p l i c a n t st ou s et h eR T O f o o t p r i n t a st h e geographic market for purposes of computing the indicative screens. Id. at P 41. In most cases where there have been screen failures, the problems were encountered in the results for the market share screen.
63 64 62 61
AEP I, 107 FERC 61,018 at P 37.
See Duke Power, 111 FERC 61,506 (2005); Kansas City Power & Light Co., 113 FERC 61,074, at P 31 (2005).
65 66
See, e.g., Heartland Energy Servs, Inc., 68 FERC 61,223, at 62,062-63 (1994). A detailed discussion of Codes of Conduct is found in Chapter 11 of this Handbook.
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concerns over the relationship of a franchised utility and its affiliate power generating company.67 Barriers to Entry. FERC requires that each applicant indicate whether it controls any barriers to entry that would prohibit competing suppliers from entering the market, such as the control of natural gas pipeline facilities.68 This factor traditionally has not been s i g n i f i c a n t i n F E R C s c o n s i d e r a t i o n o f m a r k e t -based rate applications. 2. Three-Year Updates A public utility that receives approval to sell power at market-based rates is required to resubmit a market analysis every three years.69 The three-year clock begins with the date of the order approving the tariff. The market analysis must cover the same areas discussed above and thus, as a practical matter, constitutes a re-application for market-based rates. It is i m p o r t a n t t on o t e , h o w e v e r , t h a t a p u b l i cu t i l i t y s m a r k e t -based rate authorization does not e x p i r e a t t h e e n d o f t h i s t h r e e -year period; rather, so long as the three-year update has been submitted, the applicant continues to have authority to sell at market-based rates pending F E R C s c o n s i d e r a t i o n o f t h e u p d a t e dm a r k e t a n a l y s i s .If no update is submitted on a timely basis, FERC may revoke market-based rate authority.70 If, on review of a three-year update, FERC finds that the applicant fails to pass one of the market screens, or may not satisfy any other prong of the test, FERC will institute a section 206 investigation, and set a refund effective date, to determine whether market-based rates should be revoked.71 This means that the applicant may be required to refund money to customers (typically the difference between cost-based rates and market-based rates retroactive to a refund effective date established in a section 206 Order) if FERC later finds that market-based rate authority should be revoked.72 Compliance Recommendation. Tracking the need to file such a three-year update can be a significant compliance issue for public utilities. FERC recently revoked the marketbased rate authority of a number of entities that failed to respond to an order notifying them that they had not filed their market updates on a timely basis, and requiring them to file those updates within 60 days. 73 Given that such a failure to file can result in the revocation of market-based rate authority (or conceivably other penalties), public utilities with marketbased rate authority should develop a tracking system for each seller that receives marketSee Southern Co. Energy Mktg., Inc., 111 FERC 61,146, at P 31 (2005); cf. also Virginia Elec. & Power Co., 112 FERC 61,227, at P 8 (2005).
68 69 67
See Louisville Gas & Elec. Co., 62 FERC 61,016, at 61,147-48 (1993).
See, e.g., Entergy Servs., Inc., 58 FERC 61,234, at 61,760, r e h gg r a n t e d , 60 FERC 61,168 (1992); Louisville Gas & Elec. Co., 62 FERC 61,016, at 61,148 (1993).
70 71 72 73
3E Technologies, Inc., 113 FERC 61,124 (2005). See AEP I, 107 FERC 61,018 at P 201; AEP II, 108 FERC 61,026 at P 30 & n.23. See Duke Power, 111 FERC 61,506 at P 4. 3E Technologies, supra note 69.
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based rate authority. This can be a complex matter in larger companies because special purpose subsidiaries that sell at market-based rates are created on an ongoing basis, meaning that multiple three-year updates will be required unless the companies consolidate their filings. Therefore, compliance personnel should develop, and periodically update, a list of every affiliated company that has received market-based rate authority and the date that authority was obtained (or last updated). It usually is advisable to synchronize the three-year update schedule for all affiliated companies to minimize the potential for failing to file and the burden of making multiple filings. 3. Change in Status Filings In addition to the three-year update requirement, public utilities with market-based rate authorit y a l s om u s t r e p o r t a n y c h a n g e s in s t a t u s t h a t a r e i n c o n s i s t e n t w i t h t h e f a c t s s e t forth in their requests for market-based rate authority. In Order No. 652,74 FERC modified and clarified the requirements associated with a change in status notice. It also requires market-based rate sellers to include specified language establishing the reporting requirement in their market-based rate tariffs. Perhaps the primary consideration leading to issuance of Order No. 652 was the activities of subsidiaries of Enron during the late 1990s and early 2000s. During this period, Enron applied for and was granted market-based rate authority based upon representations in its applications regarding the extent of its generation and transmission ownership or control, and its lack of market power.75 FERC granted the requested market-based rate authorization, conditioning the tariff on a triennial update filing, and requiring Enron to file notice of any material change in circumstance. As was its standard for all applicants at that time, FERC allowed Enron the option of waiting to notify it of any such change in circumstance until the triennial review.76 During the period in question, Enron entered into various agreements with power suppliers and customers, some of which allegedly provided Enron with operational control over generation and load.77 During numerous investigations instituted in association with the 2000-2001 western energy crisis, allegations were made that Enron not only failed to inform FERC in a timely fashion of material changes in circumstances, but also used certain agreements to gain and exercise market power and to manipulate the market. There was also concern that many other market participants had elected to adopt the three-year
Reporting Requirement for Changes in Status For Public Utilities With Market-Based Rate Authority, Order No. 652, 70 Fed. Reg. 8253 (Feb. 18, 2005), III FERC Stats. & Regs., Regs. P r e a m b l e s 3 1 , 1 7 5 , ( O r d e r N o . 6 5 2 ) , o r d e r o n r e h g , Order No. 652-A, 111 FERC 61,413 (2005) ( O r d e r N o . 6 5 2 -A ) .
75
74
Enron Power Mktg. Inc., 65 FERC 61,305 (1993), clarified in part, 66 FERC 61,244
(1994). See id.; Morgan Stanley Capital Group Inc., 69 FERC 61,175, at 61,695 (1994), clarified in part, 72 FERC 61,082 (1995). FERC found that El Paso Electric Company ceded control of its assets to Enron in a contractual relationship. El Paso Electric Co., 108 FERC 61,071, at P 16 (2004), reh'g denied, 111 FERC 61,269 (2005).
77 76
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update requirement instead of reporting changes in status as they occur in order to delay updating their market power studies to reflect additions to their resource portfolios. To ensure that similar circumstances would not occur in the future, FERC adopted Order No. 652 to modify the change in status requirement and to provide greater specificity as to when such a filing is required. The most significant change was that the Commission eliminated the option of deferring a change in status filing to the triennial market power update.78 A change in status filing must be made within 30 days after the event triggering such change.79 The Commission also provided important clarification regarding the nature of the actions that would trigger a change in status filing. Cumulative increases in ownership or control of 100 MW or more of generation capacity (sellers may net decreases against increases), whether through acquisition of generating facilities or through contractual arrangements. Increases in ownership or control of transmission facilities or inputs to electric power production (including fuel supply agreements that transfer control of a jurisdictional facility), whether through acquisition of ownership interests or other contractual arrangements. Transmission outages to the extent that such outages materially affect one or more of the factors of the four-part test. Affiliation with any entity that owns or controls generation or transmission facilities or inputs to electric power production, or has a franchised service territory. Any changes in status of an affiliate of the applicant that materially impact the four-part test as applied to the applicant. B. COST-BASED RATES 1. Rate Increases FERC imposes specific and detailed requirements for any public utility requesting an increase in jurisdictional cost-based rates.80 Although there are certain safe harbors for very
78 79
Order No. 652, III FERC Stats. & Regs., Regs. Preambles 31,175 at P 2.
Apparently FERC no longer is willing to provide prior approval to future ownership arrangements, but rather will require a filing within 30 days of the effective date of the change in status. See Kumeyaay Wind LLC, Letter Order, Docket No. ER05-1316-000 (Oct. 5, 2005). This presents a serious conundrum to a company seeking regulatory certainty in advance of a transaction, particularly if the company is uncertain whether the transaction could trigger market power concerns sufficient to jeopardize market-based rates.
80
See 18 C.F.R. 35.13.
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small rate increases and uncontested applications, most increases in rates (e.g., transmission service and requirements service) will require the applicant to submit a full cost-of-service study under se c t i o n3 5 . 1 3o f t h eC o m m i s s i o n s r e g u l a t i o n s .S e c t i o n3 5 . 1 3r e q u i r e s t h a t a cost-of-service study be submitted for two test years an historical test year and a prospective test year with the latter constituting the test year for which rates will be set. These cost-of-service studies require the submission of a broad range of cost and financial i n f o r m a t i o nf o r au t i l i t y se n t i r eb u s i n e s s( i.e., generation, transmission and distribution), including information on plant balances, cost of capital, operating expenses, sales forecasts, etc. The time required for preparing such a study is typically several months and may require t h ea s s i s t a n c eo fe x p e r tc o n s u l t a n t sf a m i l i a rw i t hF E R C sc o m p l e xr u l e sg o v e r n i n gt h e determination of revenue requirements and rate design. These cases are typically set for hearing and can take years to resolve (unless they are settled, which most are). 2. Cost-Based Mitigation for Certain Applicants with Market-Based Rate Tariffs In recent years, cost-based rate filings generally have been limited to increases in transmission rates or the renewal of certain limited classes of requirements sales. However, F E R C sn e w generation market power test for market-based rates has created a new generation of cost-based rate filings. The market share screen component of F E R C s m a r k e t power test is somewhat difficult for vertically integrated utilities to meet for sales within their control areas. If a utility fails this test, or chooses not to contest its application, it must submit cost-based rates instead. F E R Ch a s a d o p t e d c e r t a i n s t a n d a r d d e f a u l t r a t e s t h a t w i l l q u a l i f y a s m i t i g a t i o n , b u t also has allowed utilities to submit other cost-based rates that they believe will address F E R C s m a r k e t p o w e r c o n c erns. The standard default rates are (i) incremental cost plus 10% f o r s a l e s o f l e s s t h a no n e w e e k , ( i i ) u pt o r a t e s c a p p e da t a c o s t -based ceiling for sales of one-week to less than one year, and (iii) individual cost-based filings under section 205 for sales of one year or longer.81 There is a fairly substantial body of precedent regarding revenue requirement and rate design issues, dating from the period when most wholesale transactions were cost-based. This should guide the preparation of cost-based rate filings that are required due to the failure of market power screens. At the same time, however, much time has passed since these cases were decided and it is not yet clear whether or how FERC will apply its prior precedent i nt o d a y s e n v i r o n m e n t .To date FERC has set most of these market power default cases for hearing and has provided limited guidance as to how to 82 d e v e l o p a n u p t o c e i l i n g r a t e f o r s a l e s o f o n e w e e k o r g r e a t e r .
AEP I, 107 FERC 61,018 at P 151. These requirements were intended to track certain of the practices of utility sellers in the 1980s when wholesale competition began to flourish under cost-based ceiling rates and other forms of pricing (e.g., split-the-savings) before the advent of market-based rates. See, e.g., Indiana & Michigan Elec. Co., 10 FERC 61,295, o r d e r o n r e h g , 12 FERC 61,167 (1980); Illinois Power Co., 57 FERC 61,213 (1991). See, e.g., AEP Power Mktg., Inc., 112 FERC 61,047 (2005); Duke Power, 111 FERC 61,506. In Carolina Power & Light Co., 113 FERC 61,130 (2005), FERC accepted cost-based default rates for sales of capacity and energy in the control area of a utility that elected not to submit a generation market power analysis.
82
81
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C. AFFILIATE SALES Transactions between affiliated entities are subject to different rules than those generally applicable to market-based and cost-based sales. When a franchised utility with captive ratepayers enters into a power sales transaction with an affiliated marketer or generator, FERC is concerned that the companies will have the incentive to skew the terms of the transaction to favor the unregulated affiliate because its profits accrue to shareholders.83 FERC has therefore adopted special rules to guard against the potential for affiliate abuse in this area. Market-based rate tariffs for franchised utilities who have power marketer affiliates, or for power marketers who have franchised utility affiliates, must, as a general rule, include a provision prohibiting power sales to, or purchases from, affiliates.84 While affiliate abuse concerns typically arise in the context of market-based rates, these concerns apply as well to sales at traditional cost-based rates.85 The Commission therefore now applies the following standards to all transactions between a franchised electric utility and its unregulated marketing or generation affiliate. Short-Term Transactions. FERC allows affiliates to obtain blanket prior approval to transact on a short-term basis without seeking prior FERC approval of each individual sale if there is a liquid market index in the area to use as a benchmark for those sales. For example, FERC has allowed companies to use prices in RTO-run markets and other liquid trading hubs to price sales between affiliates.86 For such a price index to be used, however, it must be geographically relevant.87 Additionally, if a published index is used, that index must meet criteria designed to ensure that the reported price is truly an indicative market price.88 For affiliate sales at a location that is not geographically relevant to an RTO market or an
83 84
See Portland General Exch., Inc., 51 FERC 61,108, at 61,243-45 (1990).
See, e.g., Richmond County Power, LLC, 96 FERC 61,149, at 61,641-42 (2001). However, the affiliate sales rules do not apply to transactions between unregulated affiliates that have no captive ratepayers, given that the profits or losses from those accrue entirely to shareholders. See, e.g., Enron Energy Servs. Power, Inc., 81 FERC 61,267, at 62,318-19 (1997). Similarly, FERC has granted prior authorization of affiliate sales at market-based rates when the utility involved in the transaction either has no captive ratepayers (because they have retail choice) or has captive ratepayers who are otherwise protected from abuse, such as through frozen rates. See, e.g., Illinova Power Marketing, Inc., 88 FERC 61,189, at 61,649 (1999).
85 86
Southern Cal. Edison Co., 106 FERC 61,183, r e h g d e n i e d , 109 FERC 61,086 (2004).
See, e.g., Brownsville Power I, L.L.C., 111 FERC 61,398, at P 10 (2005); Union Light, Heat & Power Co., 110 FERC 61,212 (2005); Arizona Pub. Serv. Co., 101 FERC 61,028, at P 5 (2002). See Brownsville Power I, L.L.C., 111 FERC 61,398, at P 10 (2005); Richmond County Power, 96 FERC 61,149, at 61,642-43. See Price Discovery in Natural Gas and Electric Markets, 109 FERC 61,184 at P 55 (2004); Price Discovery in Natural Gas and Electric Markets, 104 FERC 61,121 at P 41 (2003). There has been at least one indication that this policy may apply as well to sales pegged to prices in RTO-run markets. See Brownsville Power I, L.L.C., Deficiency Letter, Docket No. ER05-263-001 (Jan. 14, 2005). Such an approach seems unreasonable, however, unless there is a legitimate question raised as to whether the prices set by such markets are truly indicative of market prices.
88 87
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appropriate published index, FERC generally puts the onus on the applicant to prove that its captive ratepayers will not be subject to affiliate abuse. Sales from a marketing affiliate to a franchised utility affiliate must be at a price no higher than the lowest price that the franchised utility pays to non-affiliates.89 Sales by a franchised utility to an affiliated power marketer must be made at a rate no lower than the rate charged to non-affiliates, and no lower than market.90 In addition, the utility must make the same offer, at the same time, to nonaffiliated entities, and must simultaneously post the actual price charged in the transaction.91 These requirements place an additional burden on companies to determine the appropriate price and to document their compliance efforts.92 Long-Term Transactions. For longer-term transactions where contracts are generally c u s t o m i z e d a n d t h e r e i s n ol i q u i d m a r k e t t h a t p r o v i d e s a r e l i a b l e b e n c h m a r k , FERC allows franchised utilities to purchase power from their unregulated affiliates if they meet the standards set forth in Boston Edgar.93 Boston Edgar allows a utility to justify the rate from an affiliate using a competitive solicitation (e.g., a request for proposals ( R F P ) ) , or benchmark prices from sales to nonaffiliates or other relevant transactions in the market. G i v e n t h e d i f f i c u l t y o f e s t a b l i s h i n g c o m p a r a b i l i t y i n l o n g t e r mp o w e r s a l e s t h a t w o u l d l e n d itself to benchmarking, the clearest path to approval is the competitive solicitation, and FERC has set forth specific guidelines it will use to judge a competitive solicitation. FERC requires evidence that the solicitation process was designed and implemented without any undue preference for the affiliate, that the analysis of bids did not favor the affiliate, and that the affiliate was selected based upon some reasonable combination of price and non-price factors.94 Specifically, the following criteria are used: (i) the competitive solicitation process should be open and fair; (ii) the product or products sought through the competitive solicitation should be precisely defined; (iii) evaluation criteria should be standardized and applied equally to all bids and bidders; and (iv) an independent third party should design t h e s o l i c i t a t i o n , a d m i n i s t e r b i d d i n g , a n de v a l u a t e b i d s p r i o r t ot h e c o m p a n y s 95 selection.
See Richmond County Power, 96 FERC 61,149, at 61,642-43 & n.17 (citing GPU Advanced Res., Inc., 81 FERC 61,335 (1997)). See Jersey Central Power & Light Co., 82 FERC 61,023, at 61,071 (1998); Detroit Edison Co., 80 FERC 61,348 at 62,198-99 (1997).
91 92 90
89
Id.
FERC has also indicated that it is open to other methods of ensuring protection of captive ratepayers. See FirstEnergy Trading & Power Mktg, Inc., 8 4F E R C6 1 , 2 1 4 , a t n . 7( 1 9 9 8 ) ( We do not mean to suggest, however, that the particular pricing safeguard used in GPU is the only safeguard that we would find acceptable. ) ; see also Richmond County Power, 96 FERC 61,149, at 61,643 (approving provision allowing affiliate tolling agreements subject to provisions deemed sufficient to safeguard captive ratepayers).
93 94 95
Boston Edison Co., 55 FERC 6 1 , 3 8 2 ( 1 9 9 1 ) ( Boston Edgar ) . Id. at 62,168. Allegheny Energy Supply Co., LLC, 108 FERC 61,082, at P 22 (2004).
108
Code of Conduct Implications. One important factor to bear in mind in structuring an affiliate transaction is the limitations imposed by FE R C s C o d eo f C o n d u c t .A l t h o u g ht h e Code of Conduct is described in detail in Chapter 11, we note here that the Codes limit the information that can be shared privately by a franchised utility and its unregulated affiliate. There is no blanket exception for information that is shared in entering into FERC-approved transactions such as those meeting the criteria discussed above.96 Thus, even if a corporation receives approval for its affiliates to transact on a short- or long-term basis, the corporation must comply with the information-sharing restrictions described in Chapter 11. D. ANCILLARY SERVICES FERC will grant authority for the sale of certain ancillary services at market-based rates when such sales are into an organized ancillary services market run by an ISO or RTO.97 The applicant's tariff must specify, for each ISO or RTO market, the ancillary services the applicant seeks to provide.98 Outside of organized RTO/ISO markets, ancillary services often are provided by Transmission Providers at cost-based rates. However, because certain ancillary services may be self-provided by the transmission customer, FERC has allowed market-based approaches to procurement of ancillary services by transmission customers. Sometimes the seller of such ancillary servi c e si sr e f e r r e dt oa sa t h i r d -p a r t ys e l l e r , b e c a u s et h es e l l e r i sn e i t h e r t h e transmission customer nor the transmission provider. In this context, it is more difficult to establish an appropriate market-based rate for an ancillary service. A supplier could justify a request to charge market-based rates based upon a showing that it lacks market power in the relevant product and geographic markets. However, as a practical matter, it is difficult to make such a showing, due among other things to a lack of data. Thus, as an alternative, FERC will authorize sales of ancillary services at negotiated rates by companies otherwise authorized to sell power at market-based rates subject to a series of requirements designed to promote transparency and restrict the potential to exercise market power under what is known as the Avista standard.99 These safeguards 100 are deemed necessary to guard against potential anticompetitive behavior.
Cf. LG&E Energy Marketing, Inc., 83 FERC 61,130, at 61,588 (1998) (holding that an affiliated marketer acting as a broker for the utility may not have access to market information that other non-affiliates do not have). See, e.g., NSTAR Cos., 97 FERC 61,288 (2001) (citing New England Power Pool, 85 FERC 61,379 (1998), reh'g denied, 95 FERC 61,074 (2001)).
98 99 97
96
See, e.g., Calhoun Power Co. I, LLC, 96 FERC 61,056 (2001).
Avista Corp., 87 FERC 61,223 ( Avista I ) , order on reh'g, 89 FERC 61,136 (1999) ( Avista II ) .T h eAvista requirements do not apply to sales of ancillary services into organized markets. See AES Placerita, Inc., 89 FERC 61,202, at n.2 (1999).
100
Avista I, 87 FERC 61,223, at 61,884.
109
First, the seller should establish an Internet-based site for providing information 101 regarding ancillary services transactions. The Internet site need not provide an interactive capability to execute transactions through the site, but should include postings, prior to 102 making transactions, of offers of services available and their offering prices. Additionally, the seller should promptly post the actual transaction prices after the transactions are consummated, as well as information about accepted and denied requests and the reasons 103 for denial. The seller also should file a report after the site has been operational one year (and every three years thereafter) describing its activities in the ancillary services markets.104 Second, FERC expressly carved out three situations in which sales of ancillary services by third-party suppliers would not be allowed: sales to an RTO, ISO or transco, where the RTO has no ability to self-supply ancillary services but instead depends on third parties ; sales to a traditional, franchised public utility affiliated with the third-party supplier, and sales where the underlying transmission service is on the system of the public utility affiliated with the third-party supplier ; and sales to a public utility that is purchasing ancillary services to satisfy its own open access transmission tariff requirements to offer ancillary services to its own 105 customers. From a compliance perspective, two things stand out with respect to third-party sales of ancillary services: First, companies should ensure that any such sales are pursuant to a FERC-approved tariff. Second, companies making sales outside of an RTO will need a process for periodic assessment of their compliance with Internet posting requirements. IV. PENALTIES AND REMEDIES A. CIVIL PENALTY AUTHORITY The Energy Policy Act of 2005106 provides FERC with broad new civil penalty authority for violations of Part II of the FPA, which includes section 205. It is possible that FERC could use this new authority to sanction violations of its regulations regarding power sales. This may occur in situations where the more traditional remedies of refunds to customers for overcharges, or time value refunds for late filing, are considered inadequate or inapplicable. FERC s enh a n c e dc i v i l p e n a l t ya u t h o r i t y will operate in tandem with [its]
101 102 103 104 105 106
Avista II, 89 FERC 61,136, at 69,391. Id. Id. Id. at 61,390. Avista I, 87 FERC 61,223, at n.12. Pub. L. No. 109-58, 119 Stat. 594 (2005).
110
existing authority to require disgorgement of unjust profits obtained through misconduct and/or to condition, suspend, or revoke certificate authority or other authorizations, such as 107 market-based rate authority for sellers of electric energy. B. REFUNDS FOR OVERCHARGES One common remedy applicable to power sales transactions is a requirement to r e f u n da n y o v e r c h a r g e s t oc u s t o m e r s . This authority derives from section 205(e) of the FPA, which gives FERC the authority to suspend a filed rate and require refunds of overcharges. 108 This can occur, for example, if a cost-based rate is accepted, suspended, set for hearing, and later found to be excessive. The selling utility typically would be required to refund, with interest, any amounts in excess of the rate ultimately found to be just and reasonable. C. DISGORGEMENT OF PROFITS One of the available penalties for violation of a tariff condition, potentially including failure to meet notice and posting requirements, is disgorgement of either revenues or profits. In several investigations of alleged market manipulation in western energy markets, FERC has required disgorgement of the revenues or profits derived from specific transactions alleged to be manipulative.109 However, it has not yet determined, in a litigated setting, how disgorgement should be calculated (most of the investigations have been or are expected to be settled).110 Disgorgement of gross revenues may be ordered in some instances where no incremental costs were incurred by the utility to provide the service. Calculation of gross revenues may be simple or may be complicated by multiple transactions and counterparties, netting agreements and other such arrangements. Disgorgement of net revenues, or profits, to cost-based levels may be difficult to calculate and may require cost studies and involve allocation issues. Customers who claim to be harmed by the actions at issue often seek some form of market-wide damages, particularly in organized markets, claiming that the tariff violation caused much more harm than simple disgorgement can address (for example, by causing a broad increase in market prices collected by many sellers). A make-whole payment in this context could result in a much larger remedy. To date, however, FERC has not adopted this remedial approach in any company-specific proceeding.111
Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement , 1 1 3 F E R C 6 1 , 0 6 8 , a t P1 2 ( 2 0 0 5 ) ( Enforcement Policy Statement ) .
108 109 110 111
107
16 U.S.C. 824d(e) (2003). See American Elec. Power Serv. Corp., 103 FERC 61,345 (2003). See American Elec. Power Serv. Corp., Docket Nos. EL03-137, et al.
In the California Refund case the Commission did require refunds by numerous sellers based on a calculation that purported to determine what competitive price levels should have been
111
The Enforcement Policy Statement highlights the preeminence of disgorgement in the FERC's view of its available remedies. Indeed, the Commission there noted that the enhancement o f i t s c i v i l p e n a l t y a u t h o r i t y does not mean that [it] will refrain from ordering 112 the disgorgement of unjust profits or economic benefits that are the resul t o f w r o n g d o i n g . Rather, FERC expects t h a t c o m p a n i e s w i l l b e o r d e r e d to disgorge unjust profits whenever they can be determined or reasonably estimated . . . to nullify the value of gains acquired 113 t h r o u g h m i s c o n d u c t . D. FAILURE TO FILE IN A TIMELY MANNER A utility that begins making jurisdictional sales without first having the rates for such sales approved by the Commission generally must refund the time value (interest at FERC rate, calculated pursuant to se c t i o n 3 5 . 1 9 a o f t h e C o m m i s s i o n s r e g u l a t i o n s ) o ft h e r e v e n u e s collected for the entire period that the jurisdictional service was provided without authorization.114 The time value app r o a c h , h o w e v e r , i s o n l yt h es t a r t i n gp o i n t o f F E R C s analysis. For every violation, FERC also examines whether the actual rates charged for the underlying service were just and reasonable, whether circumstances call for market-based rates to be reduced to cost-based rates, and whether the utility incurred costs to provide the service that should be taken into consideration. For example, as a matter of equity, FERC has not required that a utility pay time value refunds of the full revenue stream, if doing so will result in the utility providing service or operating its facilities at a financial loss.115 In these types of situations the Commission has directed the utility to file its refund report, but permits the utility to make a showing of its potential operating losses.116 If FERC determines that the underlying rate charged was not just and reasonable, refunds (in addition to time value refunds) could be required to a new
during the refund period. But that was based on a general finding that the market was dysfunctional, after a complaint had been filed and the refund effective date had passed, not on remedying specific tariff violations by a specific seller. See San Diego Gas & Elec. Co., 97 FERC 61,275, at 62,172-73 (2001).
112 113 114
Enforcement Policy Statement at P 19. Id.
Vermont Elec. Coop. Inc., 108 FERC 61,223, at PP 22-23 (2004), o r d e r o nr e h g , 110 FERC 61,232 (2005); see also Prior Notice, 64 FERC 61,139 at 61,979. See Carolina Power & Light Co., 87 FERC 61,083, at 61,357 (1999) (limiting application of time-value formula to an amount that permits a utility to recover its variable costs such as fuel and O&M expenses); see also Southern Cal. Edison Co., 98 FERC 61,304 (establishing a f l o o r a st ot h et o t a l a m o u n to ft i m e -value refunds in order to ensure that the utility did not ultimately construct interconnection facilities at a financial loss); Florida Power & Light Co., 98 FERC 61,276, at 62,150-5 1( 2 0 0 2 ) ( e s t a b l i s h i n g a f l o o r , a s i n Edison, a n d n o t i n g t h a t [ b e c a u s e ] the monies . . . at issue here did not include any profit, consistent with Carolina Power, we will limit the time value refunds to ensure that FP&L will be returning to [the generation company] only the interest on monies that it was never authorized to receive, with a floor to protect it from constructing s u c h f a c i l i t i e s a t a l o s s ) ( quoting Carolina Power, 87 FERC 61,083 at 61,357).
116 115
See, e.g., Carolina Power, 87 FERC 61,083, at 61,357.
112
rate level that FERC determines is just and reasonable.117 If the sales were made at an unauthorized market-based rate, then the utility may be required to refund all revenues resulting from the difference, if any, between the market-based rate and a cost-justified rate.118 As an added measure, FERC effectively may void any contracts entered into without authorization or permit the utility to charge only a cost-justified rate for the remainder of that 119 c o n t r a c t s t e r m s . Even if FERC ultimately determines that the charges at issue are just and reasonable, FERC considers its time value refund remedy necessary because the injury at issue is not to another party, but to its own enforcement authority.120 FERC considers the size of the amount owed to be an irrelevant factor.121 E. LOSS OF MARKET-BASED RATE AUTHORITY Although FERC has used its ability to revoke market-based rates only in extreme situations,122 FPA section 206 does give FERC the authority to revoke a tariff prospectively. It is far from clear, however, that FERC has the authority to cure a violation of a tariff condition by retroactively revoking the entire tariff. These issues recently were litigated in Docket Nos. EL03-180, et al., w h e r eF E R CS t a f f a n ds e v e r a l p a r t i e s a l l e g e dt h a t E n r o n s failure to notify the Commission of changes in its control of generation and load constituted such a major violation of the notification provisions of its market-based rate tariff, that all revenues/profits from all sales transacted since the commencement of the first failure to notify should be refunded.123 Ultimately the Commission approved a contested settlement in
117 118
Prior Notice, 64 FERC 61,139, at 61,979 n.11.
Id. at 61,980; Southern Cal. Water Co., 106 FERC 61,305, at PP 15-16, r e h gd e n i e d , 108 FERC 61,168 (2004).
119 120
Prior Notice, 64 FERC 61,139, at 61,980.
Carolina Power, 8 7F E R C 6 1 , 0 8 3 , a t 6 1 , 3 5 6( [ W] h e nu t i l i t i e s f a i l t of i l er a t e s i na timely manner, there i s i n j u r yt o t h e C o m m i s s i o n s a b i l i t yt oe n s u r e t h a t a l l r a t e s f o r j u r i s d i c t i o n a l service . . . are just and reasonable at the time they are being charged. F a c t o r i n g t h e d u r a t i o n o f t h e violation into the refund amount encourages utilities to practice constant vigilance not only with r e s p e c t t on e wr a t e s , b u t a l s ot oe n s u r et h a t e x i s t i n ga g r e e m e n t s a r e a p p r o p r i a t e l yf i l e d . ) ( q u o t i n g PacifiCorp Elec. Operations, 60 FERC 61,292 (1992), r e h g g r a n t e d o n o t h e r g r o u n d s , 64 FERC 61,325, at 62,039 (1993)). See Carolina Power, 87 FERC 61,083, at 61,355 (dismissing claims that the refunds w e r e e x o r b i t a n t a n dn o t i n gt h a t t h e s i z e a b l er e v e n u e sc o l l e c t e da n dt h ee x t e n d e dp e r i o do v e r w h i c h t h e yw e r e c o l l e c t e d a c c o u n t e d f o r t h e d o l l a r a m o u n t i n v o l v e d ) . T h e m e r e f a c t t h a t a r e f u n d i s l a r g e d o e s n o t n e c e s s a r i l y m a k e i t e x c e s s i v e . Id. Enron Power Mktg., Inc., 103 FERC 61,343 (2003); The Washington Water Power Co., 83 FERC 61,282 (1998). See, e.g., Direct and Answering Test. of Craig E. Deters, Witness for the Staff of the Federal Energy Regulatory Commission re Enron Power Marketing Inc. and Enron Energy Services, Inc, Enron Power Mktg., Inc., Docket No. EL03-180-000 (Jan. 31, 2005).
123 122 121
113
the case without reaching a conclusion on whether the disgorgement of all profits was the appropriate remedy.124
San Diego Gas & Elec. Co. v. Sellers of Energy and Ancillary Servs., 113 FERC 61,171 (2005). Similarly, in an ongoing case involving El Paso Electric Company, an ALJ recommended that revocation of market-b a s e dr a t ea u t h o r i t yi s ap o s s i b l es a n c t i o nf o r E l P a s o s f a i l u r et of i l ea required notification of contra c t t e r m i n a t i o n s i x t y d a y s p r i o r t o t h e c o n t r a c t s e x p i r a t i o n d a t e .TexasNew Mexico Power Co. v. El Paso Elec. Co., 108 FERC 63,045, at P 77 (2004). The Commission approved a settlement resolving all issues between the parties, thus did not reach a conclusion regarding the potential revocation of market-based rates. Texas-New Mexico Power Co. v. El Paso Elec. Co., 110 FERC 61,258 (2005).
124
Chapter 8 Transmission and Interconnection Service

GERARD A. CLARK WILLIAM R. HOLLAWAY The purpose of this chapter is to describe Federal Energy Regulatory Commission ( FERC or Commission ) regulations and orders applicable to the provision of transmission and interconnection service by public utilities. The chapter focuses principally on (i) Order No. 888, which requires public utilities to provide unbundled transmission service pursuant to a pro forma Open Access Transmission Tariff, and (ii) Order No. 2003, which requires public utilities to provide interconnection service to generators pursuant to Standard Large Generator Interconnection Procedures and a Standard Large Generator Interconnection Agreement. Each of these orders creates significant compliance issues for public utilities in applying and, in many cases, interpreting these regulations and pro forma tariffs. We provide examples of the types of uncertainties and disputes that arise under these orders, as well as a discussion of the types of remedies that FERC may impose for noncompliance. I. OVERVIEW OF ORDER NOS. 888 AND 2003
A. TRANSMISSION SERVICE PROVIDED PURSUANT TO ORDER NO. 888 Section 205 of the Federal Power Act ( FPA )1 requires FERC to ensure that the rates, terms and conditions for transmission service in interstate commerce are just, reasonable and not unduly discriminatory. With the emergence of independent (non-utility) suppliers of electricity, FERC became increasingly concerned that vertically-integrated utilities might use their ownership and control of the transmission system to discriminate against competing suppliers. To remedy this potential undue discrimination, FERC issued Order No. 888 in 1996.2
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 1998, Mr. Clark served as a partner in the law firm of Pierson Semmes and Bemis, specializing in energy litigation. Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 2000, Dr. Hollaway served as an associate in the law firm of Shaw Pittman, focusing on nuclear industry matters. Dr. Hollaway is a former U.S. Department of Energy Fellow.
1 2
16 U.S.C. 824d (2004).
Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Order No. 888, 61 Fed. Reg. 21,540 (May 10, 1996), FERC Stats. & Regs., Regs. Preambles Jan. 1991-J u n e 1 9 9 6 3 1 , 0 3 6 ( 1 9 9 6 ) ( O r d e r N o . 8 8 8 ) , o r d e r o n r e h g , Order No. 888-A, 62 Fed. Reg. 12,274 (Mar. 14, 1997), FERC Stats. & Regs., Regs. Preambles July 1996-Dec.
116
In Order No. 888, FERC required all transmission-owning public utilities to operate their transmission systems under an Open Access Transmission Tariff ( OATT ). Order No. 888 attached a pro forma OATT that specified uniform terms and conditions for transmission service.3 Transmission providers were required to use the pro forma OATT in developing their individual OATTs and were allowed to deviate from the pro forma OATT only if they could show that the deviations were consistent with or superior to the pro forma OATT. In order to promote uniformity, FERC has construed the consistent with or superior to standard as a high hurdle and has permitted deviations under that standard sparingly.4 Under Order No. 888, all transmission customers of public utilities are required to take transmission service under the transmission provider s OATT, unless, at the time Order No. 888 was issued, the customer was taking service pursuant to an existing or grandfathered transmission contract.5 In addition, the utility is required to take service under the transmission provider s OATT when transmitting its own power to wholesale customers and when delivering unbundled power to retail customers in states with retail access programs.6 Order No. 888 did not require a utility to use the OATT when providing bundled service to its retail customers.7 However, FERC subsequently ruled that Order No.
2 0 0 03 1 , 0 4 8( 1 9 9 7 ) ( O r d e r N o . 8 8 8 -A ) , o r d e r o nr e h g , Order No. 888-B, 81 FERC 61,248 (1997), o r d e r o nr e h g , Order No. 888-C, 82 FERC 61,046 (1998), a f f di nr e l e v a n t p a r t s u bn o m . Transmission Access Policy Study Group v. FERC, 225 F.3d 667 (D.C. Cir. 2000), a f f ds u bn o m . New York v. FERC, 535 U.S. 1 (2002). The original pro forma OATT is found in Appendix D of Order No. 888, FERC Stats. & Regs. 31,036 at 31,926-64. The revised and current version of the pro forma OATT is found in Appendix B of Order No. 888-A, FERC Stats. & Regs. 31,048 at 30,503-43. See, e.g., Niagara Mohawk Power Corp., 86 FERC 61,009 (1999); Public Serv. Co. of New Mexico, 82 FERC 61,127, r e h gd e n i e d , 85 FERC 61,240 (1998); New York State Elec. & Gas Corp., 78 FERC 61,114 (1997), r e h gd e n i e d , 82 FERC 61,209 (1998); Tucson Elec. Power Co., 78 FERC 61,091 (1997). In Order No. 888, the Commission declined to order generic abrogation of existing transmission contracts as it did in its unbundling of the natural gas industry. See FERC Stats. & Regs. 31,036 at 31,663-65. However, FERC did allow generic modification of requirements contracts to allow the purchaser to take open access transmission service and to allow the public utility to add a stranded cost recovery provision. See id. See id. at 31,700-01; Order No. 888-A, FERC Stats. & Regs. 31,048 at 30,216-17; see also 18 C.F.R. 35.28(c)(2) (2005). In a subsequent order, FERC required public utilities to file forms of service agreements w i t ht h e u t i l i t y s m e r c h a n t f u n c t i o nt o m a k e p u b l i ct h ef a c t t h a t [ t h e u t i l i t y s m e r c h a n t f u n c t i o n ] i s t a k i n gs e r v i c eu n d e r i t s o w nt a r i f f . Allegheny Power Sys., Inc., 80 FERC 61,143, at 61,536 (1997). See Order No. 888-A, FERC Stats. & Regs. 31,048 at 30,217. The Commission's decision not to assert jurisdiction by applying its open access remedy to bundled retail transmissions was specifically affirmed by the Supreme Court as a statutorily permissible policy choice. See New York v. FERC, 535 U.S. at 25-28.
7 6 5 4 3
TRANSMISSION AND INTERCONNECTION
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888 requires a utility to designate the network resources that are used to serve bundled retail customers.8 The requirements of Order No. 888 apply to all public utilities that provide transmission service in interstate commerce. Order No. 888 does not apply to state or municipal utilities that are not public utilitiesas defined in section 201 of the FPA.9 However, under the reciprocity requirement of Order No. 888, all transmission customers under the OATT (including non-jurisdictional utilities) must offer comparable open access transmission service in order to be entitled to receive open access transmission service from public utilities.10 FERC allows non-jurisdictional utilities to submit to FERC safe harbor tariffs and request FERC to certify that those tariffs are sufficiently comparable to the Order No. 888 pro forma OATT to satisfy the reciprocity requirement.11 Many non-jurisdictional utilities have taken advantage of this procedure and now have in place FERC-certified safe harbor tariffs. 12 In addition, Order No. 888 allowed small public utilities with limited or discrete transmission facilities that do not form part of the integrated grid to petition FERC for waiver of the requirements of Order No. 888.13 FERC generally has granted such waivers when the transmission facilities were de minimis and the public utility was unlikely to receive requests for transmission service over those facilities.14 For example, FERC has granted waivers for generators whose only transmission facilities were interconnection facilities used to interconnect the generator to the transmission system.15 However, the Commission has stated that all waivers are subject to the condition that the public utility receiving such waiver must file a pro forma tariff within 60 days of receiving a request for transmission service.16
See, e.g., Aquila Power Corp. v. Entergy Servs., Inc., 90 FERC 61,260, r e h gd e n i e d , 92 FERC 61,064 (2000), reh'g denied, 101 FERC 61,328, a f f ds u bn o m . E n t e r g y S e r v s . , I n c . v . FERC, 375 F.3d 1204 (D.C. Cir. 2004).
8 9 10
See 16 U.S.C. 824(b)(1), 824(e), 824(f). See Order No. 888, FERC Stats. & Regs. 61,036 at 31,636, 31,691; pro forma OATT See 18 C.F.R. 35.28(e).
6.
11 12
See, e.g., Umatilla Elec. Coop. Assoc., 97 FERC 61,235 (2001); Tri-State Generation & Transmission Assoc., Inc., 96 FERC 61,268 (2001); South Carolina Pub. Serv. Auth., 75 FERC 61,209 (1996). See 18 C.F.R. 35.28(d); see also Black Creek Hydro, Inc., 77 FERC 61,232, at 61,941 (1996) (permitting waivers for small public utilities that transmit less than 4 million MWh annually unless the utility is a member of a tight power pool). See, e.g., Sulphur Springs Valley Elec. Coop., Inc., 109 FERC 61,181 (2004); Golden Spread Elec. Coop., Inc., 106 FERC 61,151 (2004).
15 16 14 13
See, e.g., Entergy Louisiana, Inc., 110 FERC 61,300 (2005).
See, e.g., Soyland Power Coop., Inc., 102 FERC 61,244 (2003); Black Creek Hydro, Inc., 77 FERC 61,232 at 61,941.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK The Order No. 888 pro forma OATT covers the following areas, among others: The process for obtaining and evaluating requests for transmission service;17 The terms and conditions for network and point-to-point transmission service, including payment for those services; The types of ancillary services transmission customers must either purchase or self-provide in order to support any transmission service they receive, including the rate for purchasing those services from the transmission provider; The nature and types of studies that must be conducted to determine the availability of transmission service, and the timelines for those studies; The priorities among competing transmission service requests, including rights of first refusal and curtailment priorities; and Provisions dealing with billing and payment and risk allocation, including creditworthiness, force majeure, and indemnification.
On September 16, 2005, in Docket No. RM05-25-000, FERC issued a Notice of Inquiry seeking comments on whether reforms should be made to the Order No. 888 pro forma OATT.18 FERC stated that its preliminary view was that some reforms should be made. FERC invited comments on all aspects of the pro forma OATT, including, inter alia, transmission and expansion pricing, types of transmission and ancillary services, the processing of service requests, reservation priorities, rollover rights, changes in points of receipt and delivery, designation of network resources, and energy and generator imbalances. Initial comments to the Notice of Inquiry were due on November 22, 2005. B. INTERCONNECTION SERVICE PROVIDED PURSUANT TO ORDER NO. 2003 When issued in 1996, the Order No. 888 OATT applied to requests for transmission service, but it did not specifically address interconnection service for generators seeking to
T r a n s m i s s i o ns e r v i c ei sr e s e r v e du s i n gat r a n s m i s s i o np r o v i d e r sO p e nA c c e s sS a m e Time Information S y s t e m ( O A S I S ) ,w h i c hi si n t e n d e dt op r o v i d ee x i s t i n ga n dp o t e n t i a l transmission customers the same access to transmission information. All public utilities that own, control or operate facilities used in the transmission of electric energy in interstate commerce are required to create or participate in an OASIS by Order No. 889, which was issued concurrently with Order No. 888. See Open Access Same-Time Information System (Formerly Real-Time Information Networks) and Standards of Conduct, Order No. 889, 61 Fed. Reg. 21,737 (May 10, 1996), FERC Stats. & Regs., Regs. Preambles Jan. 1991-June 1996 31,035, at 31,583 (1996), clarified, 77 FERC 61,335 (1996), order on reh'g, Order No. 889-A, FERC Stats. & Regs., Regs. Preambles Jan. 1991June 1996 31,049 (1997), order on reh'g, Order No. 889-B, 81 FERC 61,253 (1997). Part 37 of the Commission s regulations provides requirements for operation of OASIS, as well as references to documents that provide more detailed guidance. 18 C.F.R. pt. 37.
17
See Preventing Undue Discrimination and Preference in Transmission Service, Notice of I n q u i r y , 1 1 2 F E R C 6 1 , 2 9 9 ( 2 0 0 5 ) ( N o t i c e o f I n q u i r y ) .
18
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interconnect to the transmission system. Four years later, in Tennessee Power Co.,19 FERC clarified that generator interconnection service also was covered under the OATT and encouraged transmission providers to adopt standardized generator interconnection procedures as attachments to their OATTs. In response, many jurisdictional transmission providers adopted and attached to their OATTs generator interconnection procedures and an agreement to govern requests by generators to interconnect to the transmission system.20 Subsequently, in 2003, FERC issued Order No. 2003,21 which required all FERCjurisdictional transmission providers to adopt and attach to their OATTs standard interconnection procedures and a standard interconnection agreement for new generator interconnection requests made by Large Generators i.e., generators adding capacity of 20 MW or more.22 FERC also recently issued an order requiring transmission providers to revise these standard interconnection procedures and standard interconnection agreements to add requirements specific to the interconnection of large wind generation.23 The Standard Large Generator Interconnection Procedures ( LGIP o r L G I P s ) and the Standard L a r g e G e n e r a t o r I n t e r c o n n e c t i o n A g r e e m e n t ( L G I A ) established in Order No. 2003 govern the generator interconnection process from the time of the initial request to the execution and filing of the LGIA. 24 The LGIPs and LGIA cover, inter alia, the following areas:
19 20
90 FERC 61,238 (2000).
See, e.g., Southern Co. Servs., Inc., 94 FERC 61,131, r e h gd e n i e d , 95 FERC 61,078 (2001); Virginia Elec. & Power Co., 93 FERC 61,307 (2000), r e h gd e n i e d , 94 FERC 61,164 (2001); Entergy Servs., Inc., 91 FERC 61,149 (2000), r e h gd e n i e d , 94 FERC 61,257 (2001); American Elec. Power Serv. Corp., 91 FERC 61,308 (2000), r e h gd e n i e d , 94 FERC 61,166 (2001). Standardization of Generator Interconnection Agreements and Procedures, Order No. 2003, 68 Fed. Reg. 49,846 (Aug. 19, 2003), FERC Stats. & Regs., Regs. Preambles Vol. 3 31,146 ( 2 0 0 3 ) ( O r d e r N o . 2 0 0 3 ) , o r d e r o n r e h g , Order No. 2003-A, 69 Fed. Reg. 15,932 (Mar. 26, 2004), FERC Stats. & Regs., Regs. Preambles Vol. 3 31,160 (2004), o r d e r o nr e h g , Order No. 2003-B, 109 FERC 61,287 (2004). FERC also has established standardized interconnection procedures and a standard interconnection agreement for small (less than 20 MW) generators, see Standardization of Small Generator Interconnection Agreements and Procedures, Order No. 2006, 70 Fed. Reg. 34,100 (June 13, 2005), FERC Stats. & Regs., Regs. Preambles Vol. III 31,180, o r d e r o n r e h g , Order No. 2006A, 70 Fed. Reg. 71,760 (Nov. 30, 2005), 113 FERC 61,195 (2005). See Interconnection for Wind Energy, Order No. 661, 70 Fed. Reg. 34,993 (June 16, 2 0 0 5 ) , F E R CS t a t s . &R e g s . , R e g s . P r e a m b l e sV o l . 33 1 , 1 8 6( 2 0 0 5 ) ( O r d e r N o . 6 6 1 ) , r e h g pending. FERC recently extended the date for compliance with Order No. 661 until December 30, 2005. See Interconnection for Wind Energy, Notice Extending Compliance Date, Docket Nos. RM05-4-000, RM05-4-001 (Oct. 28, 2005). The LGIPs are found at the conclusion of Order No. 2003 in Appendix C. The LGIA is likewise found at the conclusion of the LGIPs in Appendix 6.
24 23 22 21
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK procedures for requesting and evaluating requests to interconnect new generation to the transmission system or to modify existing interconnections materially (e.g., by adding capacity to an existing generator);25 studies necessary for determining safe and reliable interconnection, including the timelines for those studies;26 establishment of the interconnection queue and the management of, and priorities within, the interconnection queue;27 types of interconnection service available, including energy resource interconnection service and network resource interconnection service;28 allocation of the costs of the facilities necessary to provide interconnection service;29 and risk allocation between the transmission provider and generator, including indemnification, creditworthiness, security, defaults, and so forth.30
Under Order No. 2003, the LGIPs and LGIA apply to all requests to interconnect to the transmission system of a public utility and to requests to interconnect to the distribution system of a public utility, if the generator intends to make wholesale sales and if the distribution facilities are already subject to the transmission provider s OATT. The LGIPs also apply to the interconnection of the utility s own generation to the transmission system, 31 although FERC has not required a vertically-integrated utility s merchant function to enter into an interconnection agreement with its transmission function when interconnecting a generator to serve native load. The flexibility for a transmission provider to deviate from the terms and conditions of the LGIPs and LGIA depends on whether the transmission provider is independent,i.e., whether it has any affiliated generation interests. For a non-independent transmission provider (e.g., an integrated utility), deviations from the standard procedures and agreement are allowed only under the stringent consistent with or superior tostandard used for
25 26 27 28 29 30 31
See LGIP 3.3, 7-10. See LGIP 7-8, 10. See LGIP 4. See LGIP 3.2; LGIA art. 4.1. See LGIA arts. 5.1-5.3, 11. See LGIA arts. 11.5, 16-18.
See LGIP 1, Definitions ( d e f i n i n g I n t e r c o n n e c t i o nC u s t o m e r t om e a n a n ye n t i t y , including the Transmission Provider, Transmission Owner or any of the Affiliates or subsidiaries of either, that proposes to in t e r c o n n e c ti t sG e n e r a t i n gF a c i l i t yw i t ht h eT r a n s m i s s i o nP r o v i d e r s T r a n s m i s s i o n S y s t e m ) ( e m p h a s i s a d d e d ) .
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deviations from the OATT.32 Independent transmission providers (ISOs, RTOs or standalone transmission companies) have greater flexibility and are allowed to customize interconnection procedures and agreements to fit regional needs.33 In addition, like Order No. 888, Order No. 2003 allows small public utilities to seek from FERC waiver of the requirements of Order No. 2003.34 II. COMPLIANCE ISSUES
Order Nos. 888 and 2003 present two general categories of compliance issues for transmission providers. The first involves simply understanding and applying the specific tariff provisions adopted by each rule. The second involves areas where FERC has not been prescriptive, but rather has left certain decisions to the discretion of the Transmission Provider. The most common compliance problem in this latter category is a FERC finding that the utility exercised its discretion in a manner that favored its own generation business and, hence, engaged in undue discrimination under the FPA. We discuss each issue below as it applies to both orders, although most of the examples involve Order No. 888 because Order No. 2003 was only recently adopted.35 A. TRANSMISSION 1. Affiliate Preference in Type of Service Offered Order No. 888 requires that Transmission Providers offer third parties transmission service on a comparable basis to the service they provide to the generation portion of their business. A public utility therefore cannot offer its wholesale merchant function or generation affiliate a form of transmission service that is not available to its competitors. This occurred in Washington Water Power Co.36 In that case, FERC held that the Transmission Provider had offered to its marketing affiliate (Avista Energy, Inc.) a form of interruptible firmtransmission service that was not available to nonaffiliates under the OATT.37 As a remedy for this violation, FERC revoked the utility s market-based rate authority for six months and ordered it to disgorge the profits it earned from the unauthorized sales.38
32 33 34 35
See Order No. 2003, FERC Stats. & Regs. 31,036 at PP 825-26. See id. at PP 823-24, 827. See id. at PP 830-31; see also 18 C.F.R. 35.28(f)(3).
Compliance issues under Order No. 888 may change depending on the reforms to the pro forma OATT that FERC adopts as a result of the September 16, 2005 Notice of Inquiry. In the Notice of Inquiry, FERC has specifically requested comments on whether reforms should be made to many of the OATT provisions discussed herein. In some instances, compliance changes may be simply a tightening of existing compliance requirements. In others, the role of compliance personnel may actually decrease because FERC may eliminate existing discretion.
36 37 38
83 FERC 61,097, order on response to show cause order, 83 FERC 61,282 (1998). See id. at 61,463. See id. at 62,169.
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As another example, in Aquila v. Entergy Services, Inc.,39 FERC found that a public utility had reserved transmission interface capacity without designating network resources as required by OATT Section 28.2.40 The utility had reserved all of the firm transmission capacity at four key interfaces in order to import power to serve native load in times of emergency. FERC found that the utility was required to reserve capacity using network resource designations just like any other network customer under the OATT.41 A remedy was not ordered in that proceeding because the utility already had filed revised procedures complying with FERC's network designation requirements in a separate proceeding, and FERC found no basis to award refunds.42 FERC rejected the utility's argument that its market-based rate authority should not be revoked in the absence of proof that the utility had profited from its violation, but nevertheless declined to revoke the utility's market-based rate authority because that question was already before FERC in a separate proceeding.43 As another example, in Arizona Public Service Co.,44 the Commission issued an order approving an audit report issued by FERC s Office of Market Oversight & Investigations ( OMOI ) and directing compliance actions proposed in the audit report. In that case, OMOI s report found that the utility had allowed its wholesale merchant function to make off-system power sales at trading hubs from system resources without properly requesting, scheduling and paying for point-to-point transmission service under the OATT.45 The utility agreed to settle this and other allegations by, inter alia, making an unrecoverable payment to upgrade a transmission line, contributing to low-income energy assistance programs, and installing an independent transmission market monitor. 2. Discretion in Calculating Available Capacity Order No. 888 requires Transmission Providers to calculate the transmission capacity that is available to serve OATT customers ( ATC ), but does not mandate any specific method for calculating ATC. Transmission Providers therefore have significant discretion in the methods used to calculate ATC. Concerned that this discretion could result in discrimination, FERC recently issued a Notice of Inquiry to investigate whether ATC practices should be standardized.46 However, until such standardization occurs, the
90 FERC 61,260, r e h gd e n i e d , 92 FERC 61,064 (2000), reh'g denied, 101 FERC 61,328 (2002), a f f d s u b n o m . E n t e r g y S e r v s . , I n c . v . F E R C , 375 F.3d 1204 (D.C. Cir. 2004).
39 40 41 42 43 44 45 46
Id. at 61,859-60. See id. See id. at 61,860. See id. 109 FERC 61,271 (2004). See id. at 62,272.
See Information Requirements for Available Transfer Capability, Notice of Inquiry, 111 F E R C 6 1 , 2 7 4 , a t P9 ( 2 0 0 5 ) ( [ T ] h e r e i s a s y e t n o i n d u s t r y -w i d e s t a n d a r d f o r c a l c u l a t i n g A T C . ) .
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discretion inherent in ATC calculation will remain a significant compliance issue for many Transmission Providers.47 We provide a few examples below. ATC Calculation Methods. The traditional method of ATC calculation focuses principally on calculating the transfer capacity between interconnected control areas; it does not measure constraints that are internalto a given control area. On systems with significant internal constraints, this limitation therefore can create problems in responding to requests for transmission service under the OATT. Indeed, control area boundaries have little actual relationship to limiting transmission elements. The recent experience of the Entergy Services transmission system is one example of this problem. To address internal congestion associated with significant new merchant generation, Entergy adopted a method for evaluating constraints (the Generator Operating Limit( GOL ) methodology) that would permit generators to reserve certain capacity without requesting a system impact study.48 Although this methodology was initially well received,49 FERC s OMOI subsequently commenced an investigation regarding it and issued a report finding certain errors and quality control issues. Entergy subsequently replaced the GOL methodology with a more sophisticated method the Available Flowgate Capability ( AFC ) then in use by both the Midwestern Independent Transmission System Operator, Inc. ( MISO ) and Southwest Power P o o l ( SPP ) RTOs. This AFC method was also initially well received,50 but again issues arose regarding its implementation, with certain generators arguing that the method discriminated against them. FERC ordered a hearing regarding these allegations,51 but then later held the hearing in abeyance when it approved an Independent Coordinator of Transmission for Entergy s system to coordinate its transmission operations, including the granting or denying of transmission service requests using the AFC process.52 Capacity Benefit Margin. The use of a Capacity Benefit Margin( C B M ) also presents difficult compliance issues for Transmission Providers in calculating ATC. Prior to the adoption of Order No. 888, most utilities and power pools used a portion of their interface capacity with adjoining control areas to import power in times of system emergency (typically called CBM).53 This practice continued in many areas of the country following the adoption of Order No. 888. In a series of cases beginning in 1998, however, FERC struck
Compliance issues will remain after standardization, particularly if there are ambiguities or uncertainties in the methodology FERC adopts.
48 49 47
See Entergy Servs., Inc., 102 FERC 61,281 (2003).
See id. a t P1( 2 0 0 3 ) ( f i n d i n gt h a t t h e G O Lm e t h o d o l o g y a p p e a r s t ob e s u p e r i o r t ot h e s t a t u s q u o ) . See Entergy Servs., Inc., 106 FERC 61,115 (2004). FERC found that the AFC method a p p e a r e d t o b e a n i m p r o v e m e n t o v e r t h e t h e n -current process for evaluating short-term transmission s e r v i c e r e q u e s t s . Entergy Servs., Inc., 109 FERC 61,281, at P 3 (2004).
51 52 53 50
Entergy Servs., Inc., 109 FERC 61,281 at P 3. See Entergy Servs., Inc., 110 FERC 61,296 (2005).
See, e.g., Gainesville Utils. Dept. v. Fla. Power Corp., 402 U.S. 515, 518-19 (1971) ( T h e m a j o r i m p o r t a n c e o f a ni n t e r c o n n e c t i o ni s t h a t i t r e d u c e s t h e n e e df o r t h e i s o l a t e d u t i l i t yt o b u i l d a n d m a i n t a i n r e s e r v e g e n e r a t i n g c a p a c i t y . ) .
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down certain CBM reservations, holding that OATT Section 28.2 requires a utility to designate a network resource if it wants to reserve interface capacity.54 At the same time, however, FERC did not hold that all CBM reservations were per se unlawful. Rather, it initiated a generic inquiry on CBM and concluded that inquiry by declining to offer an opinion as to the propriety of CBM reservations, finding [we] take no position on the 55 transmission provider s ability to set aside CBM for generation reliability requirements. This has created uncertainty as to whether CBM reservations remain appropriate and, if so, in what amount and using which methodology. The issue will likely be considered in FERC s 56 recent Notice of Inquiry regarding ATC calculation, which highlights the inconsistency in CBM calculation as one of the issues for consideration. Redispatching Generation. The pro forma OATT requires that a Transmission Provider create additional transmission capacity by redispatching generation if necessary to 57 satisfy a request for firm point-to-point transmission service. The scope of this obligation has not always been clear, which has created certain compliance issues over time. For example, the OATT requires such redispatch for firm point-to-point service, but does not contain a similar provision for network service. But in Midwest Independent Transmission System Operator, Inc.,58 FERC indicated that a redispatch obligation may apply to network service. Also, issues have arisen regarding whether a Transmission Provider must redispatch its purchases of generation, or enter into new purchases, to satisfy this obligation. This issue was clarified to some degree in Arizona Public Service Co. v. Idaho Power Co.,59 which held that a Transmission Provider is not required to enter into new purchases to satisfy its redispatch obligation. The pricing of redispatch service also has created significant uncertainty. To protect native load customers from bearing the increased redispatch costs, many Transmission Providers have sought to assign such costs directly to the customers requesting the transmission service that creates the redispatch. However, FERC has rarely approved such proposals and, in the Notice of Proposed Rulemaking on Standardized Market Design, FERC noted that this has discouraged Transmission Providers from offering a separately-tariffed redispatch service in the first place:
See, e.g., Morgan Stanley Capital Group v. Illinois Power Co. , 83 FERC 61,204 (1998); Wisconsin Pub. Power Inc. SYSTEM v. Wisconsin Pub. Serv. Corp., 83 FERC 61,198 (1998); Aquila Power Corp. v. Entergy Servs., Inc., 90 FERC 61,260 (2000), o r d e r o nr e h g , 92 FERC 61,064 (2000), r e h g d e n i e d , 101 FERC 61,328 (2002), a f f d s u b n o m . , Entergy Servs., Inc. v. FERC, 375 F.3d 1204 (D.C. Cir. 2004). See Capacity Benefit Margin in Computing Available Transmission Capacity, Order Clarifying Methodology for Computing Available Transmission Capability, 88 FERC 61,099, at 61,237 (1999).
56 57 58 59 55
54
See supra note 46. See Pro Forma OATT 13.5. 98 FERC 61,075, at 62,224 (2002) 95 FERC 61,081, at 61,282 (2001).
TRANSMISSION AND INTERCONNECTION Although the existing pro forma tariff allows the recovery of generating unit redispatch costs, the Commission generally has not accepted proposals submitted by single-utility transmission providers to recover such costs. . . . Because it is difficult for a single-utility transmission provider to develop a formula that specifies the costs of redispatch and protects transmission customers interests, generation redispatch has not been used as extensively as it could be used to relieve congestion.60
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FERC has even questioned RTO methodologies for redispatch that do not involve locational marginal pricing.61 Native Load Growth and Rollover Rights. Order No. 888 provides that public utilities may reserve existing transmission capacity needed for native load growth and network transmission customer load growth reasonably forecasted within the utility s current 62 planning horizon. The standards applicable to these reservations for load growth have not, however, always been clear. One recurring example involves the situation where point-topoint customers seek to roll overa long-term reservation pursuant to Section 2.2 of the OATT.63 Order No. 888 gives utilities the right to deny such a rollover if it would trump 64 capacity needed for load growth, but Order No. 888 does not specify precisely how this should be done. In many cases, FERC has rejected load growth reservations for lack of a 65 showing of specific, reasonably forecasted native load. To provide such specificity,
See Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design, Notice of Proposed Rulemaking, 67 Fed. Reg. 55,454 (Aug. 29, 2002), FERC Stats. & Regs., Proposed Regs. 1999-2003 32,563, at PP 74-7 5( 2 0 0 2 )( S MD N O P R ) .O n J u l y 1 9 , 2 0 0 5 , t h e C o m m i s s i o n i s s u e d a n o r d e r t e r m i n a t i n g t h e p r o c e e d i n g i n i t i a t e d b y the SMD NOPR. See Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design, Order Terminating Proceeding, 112 FERC 61,073 (2005). See Midwest Indep. Transmission System Operator, Inc., 98 FERC 61,075, at 61,212 ( 2 0 0 2 ) ( r e j e c t i n gt h er e d i s p a t c hp r o v i s i o n s i nA t t a c h m e n t Ko f MI S O s p r o p o s e dR T Ot a r i f f ) ; see also Midwest Indep. Transmission System Operator, Inc. , 102 FERC 61,346, at P 15 (2003) ( a c c e p t i n g MI S O s w i t h d r a w a l o f r e d i s p a t c h s e r v i c e u n d e r A t t a c h m e n t Ku n t i l MI S Oe n e r g y m a r k e t s using locational marginal pricing went into effect).
62 63 61 60
Order No. 888, FERC Stats. & Regs. 31,036 at 31,694.
Section 2.2 gives long-t e r mf i r mt r a n s m i s s i o nc u s t o m e r st h er i g h t t o r o l l o v e r t h e i r capacity reservation at the end of their contract term, which, in effect, allows them a perpetual reservation, provided they a r e w i l l i n g t o m a t c h t h e p r i c e o f a n y c o m p e t i n g r e q u e s t a t t h e e n d o f t h e term.
64 65
Order No. 888, FERC Stats. & Regs. 31,036 at 31,694.
Nevada Power Co., 97 FERC 61,324, at 62,492-93 (2001) (holding that general statements that a transmission provider is experiencing high load growth and that its obligation to s e r v en a t i v el o a dc u s t o m e r s i s p r o j e c t e dt oi n c r e a s e s i g n i f i c a n t l y d on o t p r o v i d e as u f f i c i e n t b a s i s upon which a customer can reasonably ascertain the extent to which its rights under Section 2.2 are b e i n gl i m i t e d ) ; accord, e.g., American Elec. Power Serv. Corp., 101 FERC 61,384, at PP 14-15 (2002), r e h g d i s m i s s e d a s m o o t , 103 FERC 61,034 (2003); Southwest Power Pool, Inc., 100 FERC 61,239, at P 15 (2002) (rejecting language similar to that used in Nevada Power Co.), r e h g d e n i e d ,
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FERC has indicated that utilities can submit [a] resource plan submitted to and accepted by [a] state commission including projections of the transmission provider s need for additional 66 transmission capacity in the future to serve native load. However, even when such resource plans are submitted, FERC has found them insufficient to justify a load growth reservation.67 Also, FERC has interpreted Section 2.2 of the OATT to require that any limitations on the customers rollover rights be included in the original service agreement between the parties.68 In other words, FERC has prohibited Transmission Providers from including limitations on rollover rights in the new service agreements if there were no such limitations in the original service agreement. The D.C. Circuit recently ruled that this interpretation was not supported by the language of the pro forma OATT and, therefore, could not be applied to service agreements that were executed before the original service agreement requirement 69 was adopted in the Nevada Power case. However, the D.C. Circuit did not rule on whether this interpretation could be applied to service agreements executed after the Nevada Power case. B. INTERCONNECTION In the interconnection context, potential compliance issues also include whether the transmission provider has the correct rules in place and whether it processes interconnection requests according to those rules and in a non-discriminatory manner. The Order No. 2003 LGIPs and LGIA have become effective for transmissionowning public utilities. Under Order No. 2003, all OATTs were revised to include those standardized documents effective on January 20, 2004, unless variations were sought before that time. Further, the additional changes made under Order Nos. 2003-A and 2003-B took effect in April 2004 and January 2005, respectively. Any future deviations from these standardized procedures and agreements must be filed with and approved by FERC. Also,
103 FERC 61,293, at P 15 (2003); see also Southern Co. Servs., Inc., 103 FERC 61,117, at P 5 n.6 (2003) (listing cases). The decision in Southern Company Services, Inc. was later reversed on other grounds. See infra notes 68-69 and accompanying text. American Elec. Power Serv. Corp., 101 FERC 61,384, at P 15 (citing Nevada Power Co., 97 FERC at 62,493 n.17, for the proposition that load projections approved by state commissions may provide the support necessary to justify restricting rollover rights). See Nevada Power Co., 97 FERC at 62,493 n.17 (noting that Nevada Power supported its load projections by submitting a resource plan approved by the Nevada Public Utilities Commission, b u t f i n d i n gt h a t N e v a d aP o w e r d i dn o t s u b m i t s e r v i c ea g r e e m e n t s t h a t l i m i t r o l l o v e r r i g h t s b a s e d upon [those] specific p r o j e c t i o n s ) ( e m p h a s i s a d d e d ) . Nevada Power Co., 97 FERC at 62,492; Southern Co. Servs., Inc., 103 FERC 61,117, at P 5 n.6 (2003) (listing additional cases), r e h gd e n i e d , 108 FERC 61,174 (2004). In the recentlyterminated SMD NOPR, FERC also sought to change the wording of the pro forma OATT to include this interpretation expressly. See SMD NOPR, supra note 60, at PP 121-23, app. A.
69 68 67 66
See Southern Co. Servs., Inc. v. FERC, 416 F.3d 39 (D.C. Cir. 2005).
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any waivers from the requirements of Order No. 2003 (e.g., waivers for small public utilities) must be approved by FERC. In reviewing or auditing a transmission provider s compliance with the standardized interconnection rules, FERC is particularly interested in whether the utility treats affiliate interconnection requests in a manner similar to non-affiliate requests. For example, the LGIPs specify the interconnection studies that need to be performed and the timelines for processing those studies.70 If the study timelines cannot be met, the transmission provider must provide notice and revised timelines.71 To minimize compliance issues, transmission providers should either meet these timelines or provide the required notice if they cannot be met. Also, transmission providers should use the same interconnection studies and study methodologies for affiliate and non-affiliate requests and process affiliate and non-affiliate requests under the same timelines. While it is understandable that such timelines may vary due to the individualized nature of the requests, shorter timelines for affiliate requests may be subject to audit scrutiny. To avoid or minimize such scrutiny, companies may wish to take steps to ensure that affiliate requests are not processed faster. In any event, careful documentation of the timing is prudent. The filing requirements for interconnection agreements also may give rise to specific compliance issues. Under Order No. 200172 and Order No. 2003, LGIAs do not need to be filed with the Commission but only listed in electronic quarterly reports.73 However, if an interconnection agreement varies in any way from the standardized terms and conditions, then that agreement needs to be filed under section 205 of the FPA.74 Also, if an interconnection agreement is terminated for any reason other than expiration under its terms, then a notice of termination must be filed with and approved by FERC.75 An additional filing issue involves preliminary agreements to fund interconnection facilities and upgrades before the interconnection process is complete. The standardized interconnection procedures allow the parties to enter into an Engineering and Procurement ( E&P ) Agreement in order to begin the purchase and construction of the necessary
70 71 72
See LGIP 6-8, 10. See LGIP 6.3, 7.4, 8.3, 10.3.
Revised Public Utility Filing Requirements, Order No. 2001, 67 Fed. Reg. 31,043 (May 8 , 2 0 0 2 ) , F E R CS t a t s . &R e g s . , R e g s . P r e a m b l e s V o l . 3 3 1 , 1 2 7( O r d e r N o . 2 0 0 1 ) , r e h gd e n i e d , Order No. 2001-A, 100 FERC 61,074, reconsideration and clarification denied, Order No. 2001-B, 100 FERC 61,342; further order, Order No. 2001-C, 101 FERC 61,314 (2002). See Order No. 2003, FERC Stats. & Regs. 31,146 at P 913 & n.173 (citing Order No. 2001, FERC Stats. & Regs. 31,127 at P 18). See Chapter 4 of this Handbook for further discussion of electronic quarterly reports.
74 75 73
See Order No. 2003, FERC Stats. & Regs. 31,146 at PP 914-15. See Order No. 2001, FERC Stats. & Regs. 31,127 at P 249.
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interconnection facilities that have long construction lead times. 76 These E&P Agreements must be filed with the Commission under section 205 of the FPA.77 If they are not filed, the transmission-owning utility may have to refund the time value of the money collected under those agreements during the period when the agreements were not on file.78 III. COMPLIANCE RECOMMENDATIONS
Each transmission-owning public utility should have a compliance process to ensure compliance with FERC s transmission and interconnection rules under Order Nos. 888 and 2003.79 This process should include a monitoring/audit program for both interconnection requests and transmission service requests. For interconnection requests, since those requests may be relatively infrequent, compliance personnel may wish to attend key meetings or receive reports on those meetings to monitor for comparability issues, discussed in this subsection, and Standards of Conduct issues, addressed in Chapter 10. For transmission service requests, the program should include periodic audits to ensure that all requests for transmission service by affiliates are: (1) made through OASIS; (2) for standard service; (3) processed comparably to other requests; and (4) otherwise non-discriminatory. These procedures are important to managing the risks imposed by FERC s new civil penalty authority (up to $1 million per day per violation), which now attaches to violations of Order Nos. 888 and 2003. For public utilities in an RTO, or whose transmission service is provided by a FERCapproved independent entity, there are fewer compliance issues, and the compliance program does not need to be complex. Such utilities should inventory their remaining responsibilities
See LGIP 9. Note that Order No. 2003 specifically requires the Interconnection c u s t o m e r t ob e a r t h e c o s t r i s ki f i t c h o o s e s t ou s e t h i s o p t i o n a l p r o c e d u r e . Id.; accord Order No. 2003, FERC Stats. & Regs. 31,146 at P 228. See, e.g., GenPower Anderson, LLC v. Duke Energy Corp., 101 FERC 61,038, at P 13 & nn.10 & 11 (2002) (citing American Elec. Power Serv. Corp., 96 FERC 61,136, at 61,570 (2001); Prior Notice Filing Requirements Under Part II of the Federal Power Act, 64 FERC 61,139, at 61,982 (1993); Western Mass. Elec. Co., 61 FERC 61,182, at 61,662-64 (1992)). In GenPower Anderson, LLC, decided before Order No. 2003 was issued, Duke argued that the Notice of Proposed R u l e m a k i n gf o rO r d e rN o . 2 0 0 3 p r o v i d e [ d ]f o rt h ee x e c u t i o no fe n g i n e e r i n ga n dp r o c u r e m e n t agreements without suggesting t h a t s u c h a g r e e m e n t s m u s t b e f i l e d . Id. at P 10. FERC nevertheless h e l dt h a t t h e a g r e e m e n t m u s t b e f i l e db e c a u s e i t i n v o l v e s t h e c o n s t r u c t i o no f f a c i l i t i e s n e c e s s a r yt o p r o v i d e j u r i s d i c t i o n a l t r a n s m i s s i o n s e r v i c e s a n d [ a ] l l c h a r g e s a s s e s s e d t o r e c o u p the cost of facilities u s e d t o p r o v i d e t r a n s m i s s i o n s e r v i c e a r e j u r i s d i c t i o n a l r a t e s . Id. at 15. That holding did not change u n d e r O r d e r N o . 2 0 0 3 , w h e r e F E R C a d o p t [ e d ] S e c t i o n 9i n t h e F i n a l R u l e a s p r o p o s e d . O r d e r N o . 2003, FERC Stats. & Regs. 31,146 at P 228.
78 79 77
76
See Western Mass. Elec. Co., 61 FERC at 61,664-65 (citing cases).
In the case of a small public utility that has obtained waiver of the requirements of Order N o . 8 8 8 , t h e c o m p l i a n c e p r o g r a mm a y b e l i m i t e d t o e s t a b l i s h i n g a t r i g g e r f o r review of compliance issues. See Black Creek Hydro, Inc., 77 FERC 61,232, at 61,941 (1996).
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regarding the operation of the transmission system and make sure through the audit process that those responsibilities are discharged in a non-discriminatory manner.80 IV. POTENTIAL PENALTIES
Any failure by a transmission provider to comply with its requirements under Order No. 888 s OATT or Order No. 2003 s LGIP and LGIA would constitute a tariff violation by the transmission provider. Sections 205 and 206 of the FPA have long provided FERC with the remedial discretion to require a transmission provider to refund any amounts improperly collected from ratepayers as the result of a tariff violation.81 However, the Energy Policy Act 82 o f 2 0 0 5( E P A c t 2 0 0 5 ) now provides FERC with the additional authority to punish tariff violations by imposing civil penalties of up to $1 million per day per violation of any rule or order issued in conn e c t i o nw i t ht h eC o m m i s s i o n s jurisdiction to regulate wholesale power sales and transmission in interstate commerce under the FPA.83 In addition, FERC may adopt non-monetary remedies to address violations of Order No. 888 or Order No. 2003.84 For example, in Washington Water Power Co.,85 FERC revoked a utility s market-based rate authority in part because it offered its merchant affiliate a form of transmission service that was not made available to nonaffiliates.86 Alternatively, FERC may require utilities to adopt significant structural changes to ensure greater transmission independence as another way of addressing violations sounding in discrimination. For example, in Tucson Electric Power Co. 87 and Arizona Public Service Co.,88 both utilities agreed to install an independent market monitor to address, in part,
80 81
See Chapter 17 of this Handbook for a discussion of compliance with RTO requirements.
See, e.g., Louisiana Pub. Serv. Comm'n v. FERC, 174 F.3d 218, 224-25 (D.C. Cir. 1999); Towns of Concord v. FERC, 955 F.2d 67, 76 (D.C. Cir. 1992); Niagara Mohawk Power Corp. v. FPC, 379 F.2d 153, 159 (D.C. Cir. 1967); Southern Co. Servs., Inc., 110 FERC 61,362, at P 6 n.7 (2005); Entergy Servs., Inc., 104 FERC 61,061, at P 17 (2003).
82 83
Pub. L. No. 109-58, 119 Stat. 594, 980 (2005).
See id. 1284(e), 119 Stat. at 980 (amending section 316A of the FPA, 16 U.S.C. 825o1). The Commission has recently issued a policy statement explaining the factors it will rely upon in assessing penalties under the new statute. See Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 1 1 3F E R C 6 1 , 0 6 8( 2 0 0 5 ) ( Enforcement Policy Statement ) . A detailed discussion of FERC's new penal authority and the Enforcement Policy Statement is found in Chapter 3 of this Handbook. As the Commission explained in the Enforcement Policy Statement, i t s e n h a n c e dc i v i l penalty authority will operate in tandem with [its] existing authority to require disgorgement of unjust profits obtained through misconduct and/or to condition, suspend, or revoke certificate authority or other authorizations, such as market-b a s e dr a t e a u t h o r i t yf o r s e l l e r s o f e l e c t r i ce n e r g y . 1 1 3F E R C 61,068 at P 12.
84 85 86 87 88
83 FERC 61,097 (1998). See id. at 62,462-63. 109 FERC 61,272 (2004). 109 FERC 61,271 (2004).
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allegations that their transmission business had favored their merchant affiliates in various ways.89 Similarly, after ordering a hearing in Entergy Services Inc. 90 to investigate allegations that the utility was exercising market power in transmission, the Commission decided to hold that investigation in abeyance until it had the opportunity to issue an order in a separate proceeding where Entergy proposed to contract with an Independent Coordinator of Transmission to oversee certain operations on the Entergy transmission system. 91
See Tucson Elec. Power Co., 109 FERC 61,272 at P 4; Arizona Pub. Serv. Co., 109 FERC 61,271 at P 4; see also UniSource Energy Corp., 109 FERC 61,047 (2004) (approving the market monitoring plan submitted by Tuscon Electric Power Co.).
90 91
89
111 FERC 61,145 (2005).
See id. at P 12 & n.11; see also Entergy Services, Inc., 110 FERC 61,295, at P 11 ( 2 0 0 5 ) ( i s s u i n g a d e c l a r a t o r y o r d e r f i n d i n g t h a t E n t e r g y s I C Tp roposal may improve transparency of t r a n s m i s s i o n i n f o r m a t i o n , e n h a n c e t r a n s m i s s i o n a c c e s s , a n d r e l i e v e t r a n s m i s s i o n c o n g e s t i o n ) .
Chapter 9 Market Behavior Rules

CHERYL FOLEY I. INTRODUCTION
Sellers of wholesale power that have received market-based rate authority from the Federal E n e r g yR e g u l a t o r yC o m m i s s i o n( F E R C or C o m m i s s i o n ) are subject to rules governing their behavior in wholesale energy markets. As of this printing, those rules are in a state of flux. Currently, all sales for resale at market-based rates must comply with FERC's 1 Ma r k e t B e h a v i o r R u l e s . The Market Behavior Rules were adopted by FERC in response to trading practices that received widespread coverage in the trade press and even the popular press under eye-c a t c h i n gn a m e ss u c ha s D e a t hS t a r , G e tS h o r t y , F a tB o y , a n d R i c o c h e t . These rules provide strong remedies that seek to deter market participants from engaging in not only the practices specified in the rules, but also any future practices that m i g h t c o n s t i t u t e m a r k e t m a n i p u l a t i o n . As explai n e d i n m o r e d e t a i l b e l o w , F E R C s original efforts to define market manipulation were intentionally vague in order to leave room for the standards to evolve. The Energy Policy Act of 2005 ( E P A c t2 0 0 5 )broadened the Commission s 2 authority to prohibit manipulation of energy markets. In response, the Commission has issued several orders and notices of proposed rulemaking that would replace the Market
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 2001, Ms. Foley served as vice president, general counsel and corporate secretary of Cinergy Corp. and its predecessor, PSI Resources, Inc. She currently is representing Cinergy in its petition for judicial r e v i e wo f F E R C s Ma r k e t B e h a v i o r R u l e s n o wp e n d i n g b e f o re the United States Court of Appeals for the District of Columbia Circuit. Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Amending Market-Based Rate Tariffs and Authorizations, 105 FERC 61,218 ( 2 0 0 3 ) ( Ma r k e t B e h a v i o r R u l e O r d e r ) , r e h g d e n i e d , 1 0 7 F E R C 6 1 , 1 7 5 ( 2 0 0 4 ) ( Ma r k e t B e h a v i o r R u l e O r d e r o nR e h e a r i n g ) , appeal docketed, Cinergy Mktg. & Trading, LP v. FERC, No. 04-1168 (D.C. Cir. filed May 28, 2004). EPAct 2005, Pub. L. No. 109-58, 315, 1283, 119 Stat. 594 (2005). Under new section 2 2 2 o f t h e F e d e r a l P o w e r A c t ( F P A ) , i t i s u n l a w f u l f o r a n y e n t i t y . . . , d i r e c t l y o r i n d i r e c t l y , t o u s e or employ, in connection with the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission, any manipulative or deceptive device or contrivance (as those terms are used in section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b))), in contravention of such rules and regulations as the Commission may prescribe a s n e c e s s a r y o r a p p r o p r i a t e i n t h e p u b l i c i n t e r e s t o r f o r t h e p r o t e c t i o no f e l e c t r i c r a t e p a y e r s . See 16 U.S.C. 824v. An analogous provision was added as new section 4a of the Natural Gas Act ( N G A ) . See 15 U.S.C. 717c-1.
2 1
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Behavior Rules with n e wm a r k e t m a n i p u l a t i o nr u l e s( Ma r k e t Ma n i p u l a t i o nR u l e s ) and provide additional guidance on which types of conduct are prohibited and which are not.3 The proposed Market Manipulation Rules provide that: it shall be unlawful for any entity, directly or indirectly, in connection with the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission, . . . (1) to use or employ any device, scheme, or artifice to defraud, (2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (3) to engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person.4 Thus, while the Market Behavior Rules apply only to sellers under market-based rate tariffs, the proposed Market Manipulation Rules apply to the purchase or sale of energy and transmission service.5 Though the Market Manipulation Rules were not finalized in time to be reflected in this chapter, FERC has indicated that it intends to subsume the Market Behavior Rules in the Market Manipulation Rules.6 Therefore, a compliance program consistent with the Market
See Prohibition of Energy Market Manipulation, Notice of Proposed Rulemaking, 113 FERC 61,067 (2005) (proposing new regulations to implement FPA section 222 and NGA section 4 a ) ( Ma r k e t Ma n i p u l a t i o nR u l e s O r d e r ) ; Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Proposing Revisions to Market-Based Rate Tariffs and Authorizations, 113 FERC 61,190 (2005) (proposing repeal of the Market Behavior Rules once final Market Manipulation Rules are issued and FERC has incorporated other aspects of the Market B e h a v i o r R u l e s i n t o a p p r o p r i a t e C o m m i s s i o n o r d e r s , r u l e s a n d r e g u l a t i o n s ) ( Ma r k e t B e h a v i o r R u l e s R e p e a l O r d e r ) ; Amendments to Codes of Conduct for Unbundled Sales Service and for Persons Holding Blanket Marketing Certificates, Notice of Proposed Rulemaking, 113 FERC 61,189 (2005) (proposing to repeal regulations requiring pipelines and all gas sellers for resale to adhere to a code of conduct once the final Market Manipulation Rules are issued and FERC has incorporated other aspects of the gas code of conduct rules into appropriate Commission orders, rules and regulations).
4 5 3
Market Manipulation Rules Order, 113 FERC 61,067 at P 8.
Even before EPAct 2005, FERC had begun to extend the applicability of the Market Behavior Rules beyond market-based rate tariffs of individual sellers. For example, FERC directed t h e Mi d w e s t I n d e p e n d e n t T r a n s m i s s i o n S y s t e mO p e r a t o r , I n c . ( MI S O ) , t o r e v i s e i t s e n e r g y m a r k e t s tariff to include Market Behavior Rule 2 (i.e., the rule that directly prohibits market manipulation). Midwest Indep. Transmission Sys. Operator, Inc., 108 FERC 61,163, at P 356, reh'g denied, 109 FERC 61,157, at PP 264-66 (2004). In a subsequent order, FERC stated that incorporation of this rule in the MISO tariff would allow FERC to address market manipulation by entities taking service under the MISO tariff even if the manipulative activity in part occurs under a pre-Order No. 888 g r a n d f a t h e r e d a g r e e m e n t .Midwest Indep. Transmission Sys. Operator, Inc., 111 FERC 61,042, at PP 306-09 & nn.291-94 (2005) (clarifying the application of Market Behavior Rule 2 to transactions under grandfathered transmission agreements).
6
Market Behavior Rules Repeal Order, 113 FERC 61,190 at PP 14-19.
MARKET BEHAVIOR RULES
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Behavior Rules should provide a solid foundation for a program for compliance with the Market Manipulation Rules.7 As discussed more fully below, practices that may be penalized under the Market Behavior Rules and likely under the Market Manipulation Rules include: withholding of generation contrary to market rules; engaging in pre-a r r a n g e d w a s h t r a d e s t h a t o f f s e t t r a d e s o f t h e s a m e p r o d u c t b y the same parties; creating and relieving false transmission network congestion; collusion for the purpose of manipulating market prices, market conditions, or market rules; false reporting of transactional information to published indexes, FERC, market monitors, or transmission providers; and any other form of trading, market behavior or information reporting that FERC d e c i d e s i s m a r k e t m a n i p u l a t i o n . FERC s wording in this area is broad and vague. The intent was to address not only existing trading strategies and activities that FERC believes to be manipulative,8 but also to provide latitude for FERC to penalize new types of manipulation that arise in the future.9 Thus, FERC stated that what constitutes manipulation is subject to future development.10
7
FERC Staff also will begin providing no-action letters to further ameliorate regulatory risk. Informal Staff Advice on Regulatory Requirements, Interpretive Order Regarding No-Action L e t t e r P r o c e s s , 1 1 3 F E R C 6 1 , 1 7 4 ( 2 0 0 5 ) ( N o -Action Letter Proce s s O r d e r ) . FERC believes that the potential for market manipulation may exist in any region where evolution towards a competitive market is not yet complete, where the design structure of the market is otherwise ill-equipped to promote competition, or where supply/demand imbalances cause the market to be in disequilibrium. In those regions in which a functional organized market exists, the proposed market rules are intended only to supplement any additional tariff conditions or market rules that may apply to sellers. Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Seeking Comments on Proposed Revisions to Market-Based Rate Tariffs and Authorizations, 1 0 3 F E R C 6 1 , 3 4 9 , a t P1 1 ( 2 0 0 3 ) ( J u n e 2 6 O r d e r ) . At the time of this printing, appeals remain pending with respect to the Market Behavior Rules, with certain parties arguing, on the one hand, that the generic anti-manipulation language in Rule 2 is unlawfully vague and cannot be applied retroactively, and, on the other hand, that marketbased rates are illegal under the FPA; that the remedies for engaging in manipulative activities should be expanded; that the time limits for filing a complaint are unlawful; that motive, intent, and due diligence on the part of seller are irrelevant; and that FERC should have expanded the definition of manipulation to prohibit other types of activities. See Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 41 (stating that the anti-manipulation rule (Mar k e t B e h a v i o r R u l e 2 ) h a s b e e nd e s i g n e dt or e m a i nf l e x i b l e. . . t o
10 9 8
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Moreover, FERC crafted the rul e s a s c o n d i t i o n s i n s e l l e r s m a r k e t -based rate tariffs so that it could require refunds for tariff violations under section 205 of the FPA without having to initiate a new investigation under FPA section 206. 11 By imposing the rules as tariff conditions under section 205, FERC intended to avoid the refund date restriction imposed by section 206 and to make sales under market-based rate tariffs that are later deemed to be manipulative subject to refund from the date of the violation. Thus, the rules create fairly open-ended compliance risk in terms of both the substantive nature of what might constitute a violation and also the time period over which a refund or other penalty may be imposed. The significance of this uncertainty has only increased since the passage of EPAct 2005, which strengthens FERC's authority in this area by allowing FERC to impose civil penalties up to $1 million per day per violation.12 As previously noted, EPAct 2005 also revises the FPA to explicitly prohibit market manipulation, as FERC may define it, and requires FERC to adopt rules and reporting requirements that are intended to promote market transparency.13 Set forth below are explanations of each of the Market Behavior Rules, as adopted prior to EPAct 2005, along with a discussion of uncertainties, compliance issues that they may raise, and specific compliance program recommendations. II. THE RULES
A. MARKET BEHAVIOR RULE 1 UNIT OPERATION Ma r k e tB e h a v i o rR u l e1( R u l e1 )r e q u i r e st h a ts e l l e r sw i t hm a r k e t -based rate a u t h o r i t y o p e r ate and schedule generating facilities, undertake maintenance, declare outages, and commit or otherwise bid supply in a manner that complies with the 14 Commission-a p p r o v e dr u l e s a n dr e g u l a t i o n so f t h ea p p l i c a b l ep o w e r m a r k e t . The rule does not impose new substantive requirements on sellers, but rather incorporates by reference rules that already exist and, importantly, attaches a refund obligation to a violation of those rules. In most organized markets there are specific rules respecting unit operations,
p r o h i b i t . . . m a r k e t a b u s e s w h o s e p r e c i s e f o r ma n dn a t u r e c a n n o t b e e n v i s i o n e dt o d a y ) ; id. at P 88 (stating that the anti-m a n i p u l a t i o nr u l e i sc o n s t r u c t e di ns u c haw a yt h a t i t c a na p p ly to conduct w h o s e s p e c i f i c f o r ma n d n a t u r e m a y n o t b e k n o w n t o d a y ) . When FERC drafted the Market Behavior Rules in 2004, FPA section 206 provided that rates charged under existing tariffs were subject to refund no earlier than 60 days after the initiation of a complaint (i.e., t h e r e f u n de f f e c t i v ed a t e ) .S e c t i o n2 0 6n o wp r o v i d e st h a t r e f u n d sm a yb e awarded from the date a complaint is filed. See EPAct 2005 1285, 119 Stat. at 980-81 (amending FPA section 206, 16 U.S.C. 824e(b)). Id. 1284, 119 Stat. at 980 (amending FPA section 316A, 16 U.S.C. 825o-1). EPAct 2005 also increased criminal penalties for knowing and willful violations to include a fine of up to $1,000,000, imprisonment for not more than 5 years, or both. See id. (amending FPA section 316, 16 U.S.C. 825o).
13 14 12 11
See id. 1281, 119 Stat. at 978-79. Market Behavior Rule Order, 105 FERC 61,218 at App. A.
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maintenance and outages. Rule 1 simply requires that those rules be followed. In bilateral markets not operated by an ISO or RTO, however, there typically are few rules (other than North American Electric Reliability Council standards which historically were not enforceable by FERC) that govern these activities. Again, Rule 1 does not impose new standards for these regions, but rather incorporates by reference whatever enforceable standards may exist. Several organized markets have adopted provisions, su c h a s m u s t r u n r e q u i r e m e n t s and other standards that determine when a unit may be taken offline for routine maintenance and otherwise when units must be made available for bid or sale into the market. Although the market requirements may seem straightforward, actual implementation can raise compliance issues. For example, how is an emergency outage managed and what standards c o n s t i t u t e a n e m e r g e n c y ? I s a r e a s o n a b l e n e s s s t a n d a r da p p l i e dt ot h e d u r a t i o n o f e i t h e r an emergency or a scheduled outage? How are environmental and permitting restrictions i n c o r p o r a t e di n t oo r g a n i z e dm a r k e t s o p e r a t i n gp r o t o c o l s ?D o e s as e l l e r h a v eu n r e s t r i c t e d discretion to manage its fuel supplies and emission allowances as they relate to unit operation? Answers to these and similar questions may differ from market to market, and compliance with Rule 1 will require detailed familiarity with the requirements and standards of each market in which a company owns generation. Additionally, in an organized market, frequent communication with the market operator will be an important compliance factor. There may be a fine line between what is a perfectly legitimate operating or financial d e c i s i o na n dw h a t c o u l db ef o u n dt ov i o l a t et h eo r g a n i z e dm a r k e t s r u l e s .O p e nl i n e s o f communication with the market operator can alert both parties to differences of interpretation and forestall what might otherwise be a complaint under Rule 1, if caught and resolved early. T h e l a n g u a g e i n R u l e 1 r e q u i r i n gt h a t s e l l e r s o t h e r w i s e b i d s u p p l y i n a manner that complies with applicable market rules is, from a compliance standpoint, extremely openended and subject to multiple variations, depending on the market(s) in which a seller operates. The reach of this provision of Rule 1 may be far more geographically expansive than the unit operation requirements, because a seller/marketer may be operating in multiple markets or even nationwide. A detailed familiarity of each trader with the bidding structures and protocols of each market into which he or she sells is necessary. Whereas this knowledge and expertise was requisite in the past from a pure business standpoint, Rule 1 now also makes market expertise a compliance issue. Generally, as noted above, Rule 1 does not require sellers to bid or supply electric energy or other electric products unless such requirement is part of the market rules referred to above. However, even if failure to offer all available supply is not per se a violation of Rule 1, both physical withholding15 and economic withholding16 of supply have been hotly
P h y s i c a l w i t h h o l d i n gi sd e f i n e da s n o t o f f e r i n ga v a i l a b l es u p p l yi no r d e r t or a i s et h e market clearing price. Such a strategy is only profitable for a firm that benefits from the higher price i n t h e m a r k e t . Ma r k e t B e h a v i o r R u l e O r d e r , 1 0 5 F E R C 6 1 , 2 1 8 a t P1 0 2 n . 5 6 .
15
E c o n o m i c w i t h h o l d i n g i s d e f i n e d a s b i d d i n g a v a i l a b l e s u p p l y a t a s u f f i c i e n t l y h i g h p r i c e in excess o f t h e s u p p l i e r s m a r g i n a l c o s t s a n do p p o r t u n i t yc o s t s s ot h a t i t i s n o t c a l l e do nt or u na n d where, as a result, the market clearing price is raised. Such a strategy is only profitable for a firm that b e n e f i t s f r o mt h e h i g h e r p r i c e i n t h e m a r k e t . Id. at P 102 n.57.
16
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contested issues in several proceedings,17 with allegations that sellers have intentionally withheld supply for the purpose of manipulating market prices, and FERC could find that such withholding is a violation of Market Behavior Rule 2.18 B. MARKET BEHAVIOR RULE 2 MARKET MANIPULATION Under Marke t B e h a v i o r R u l e2( R u l e2 ) , s ellers are prohibited from engaging in a c t i o n s o r t r a n s a c t i o n s t h a t a r e w i t h o u t a l e g i t i m a t e b u s i n e s s p u r p o s e a n dt h a t a r e i n t e n d e d to or foreseeably could manipulate market prices, market conditions, or market rules for 19 e l e c t r i c e n e r g y o r e l e c t r i c i t y p r o d u c t s . This includes, without limitation: 1. Rule 2(a) Wa s h T r a d e s R u l e 2 ( a ) p r o h i b i t s w a s h t r a d e s , t h a t i s , p r e -arranged offsetting trades of the same product among the same parties, which involve no economic risk and no net change in 20 b e n e f i c i a l o w n e r s h i p . Transactions meeting this definition are a per se violation of Rule 2(a). In adopting this definition, FERC declined to limit wash trades to trades occurring at the same delivery point or substantially at the same point in time, but recognized that transactions such as exchange transactions, bookouts, and sleeve transactions that are not prearranged and have a legitimate business purpose are not included under the definition of wash trades.21 From a compliance standpoint, it is possible and not entirely uncommon for wash trades to occur inadvertently in situations where two traders in the same organization may be making concurrent, offsetting trades, unbeknownst to each other, or when a seller is dealing through a third party broker and cannot identify where and to whom certain of its sales are being made. Although intent is not an element of Rule 2(a) (i.e., wash trades are a per se violation),22 due diligence actions taken by a seller to avoid even inadvertent wash trades may work in its favor in the event of a complaint or investigation.23 Because wash trades, by
See, e.g., Investigation of Anomalous Bidding Behavior, Order Requiring Demonstration That Certain Bids Did Not Constitute Anomalous Market Behavior, 103 FERC 61,347 (2003). I nr e a c h i n gt h i s c o n c l u s i o n , h o w e v e r , [ t h a t c e r t a i nl a n g u a ge in Rule 2 was redundant] we are not finding that physical withholding, or economic withholding, cannot be a component of an a c t i v i t yt h a t c o n s t i t u t e s m a r k e t m a n i p u l a t i o n , a s p r e s c r i b e db yMa r k e t B e h a v i o r R u l e2 . Ma r k e t Behavior Rule Order, 105 FERC 61,218 at P 102 (footnotes omitted).
18 19 20 17
Id. at App. A.
Id. See also Chapter 18, discussing the jurisdiction of the Commodity Futures Trading Commission over wash trades.
21 22
Market Behavior Rule Order, 105 FERC 61,218 at P 56.
Importantly, however, intent is an element of EPAct 2005's anti-manipulation provision under certain circumstances. Market Behavior Rules Repeal Order, 113 FERC 61,190 at P 15. See generally Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 113 FERC 61,068, at P 22 (2005) (noting that FERC will consider, when assessing p e n a l t i e s , s t e p s t a k e n b y e n t i t i e s t o p r e v e n t m i s c o n d u c t ) ( Enforcement Policy Statement ) .
23
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t h e i r n a t u r e , d o n o t i n v o l v e a n y d i r e c t p r o f i t s t o r e f u n d o r d i s g o r g e , p r o o f t hat a wash trade was inadvertent could help to reduce or eliminate any damages a seller may be assessed for having engaged in it. 2. Rule 2(b) Submission of False Information R u l e2 ( b ) p r o h i b i t ss e l l e r sf r o mc o n d u c t i n g t r a n s a c t i o n sp r e d i c a t e do ns u b m i t t i ng false information to transmission providers or other entities responsible for operation of the transmission grid (such as inaccurate load or generation data; or scheduling non-firm service for products sold as firm), unless Seller exercised due diligence to prevent such 24 o c c u r r e n c e s . Rule 2(b) thus incorporates a due diligence standard that would allow a seller with a comprehensive compliance program to establish a rebuttable presumption that it did not knowingly or intentionally engage in the submission of false information.25 Conversely, the absence of internal efforts designed to assure submission of accurate and complete information could make it difficult to counteract an inference of intent on the part of the seller, whether accurate or not. FERC has not indicated what actions might constitute due diligence adequate to relieve a seller from liability,26 but corporate efforts to train employees and to establish a system of internal controls and audits would no doubt be considered. In its Enforcement Policy Statement, FERC set forth various factors that it will take into consideration in evaluating enforcement actions it may take and penalties it may impose for violations under the FPA. Among other things, it will examine the breadth, scope and implementation of internal compliance mechanisms, whether, when and how the company self-reported the purported violation, and the extent of the company's cooperation with FERC in its investigation of the purported violation.27 It is interesting to note that if an entity is found to have a satisfactory process in place to prevent the submission of false information, it is possible that the entity may not be found to have violated Rule 2(b), even if an individual within the entity knowingly and intentionally submitted the false information. 28 It is important to note in this regard, however, that the state of mind of the individual employee is a relevant factor,29 p a r t i c u l a r l yi nd e t e r m i n i n gw h e t h e r t h ee n t i t y sc o m p l i a n c ep r o c e s si s a d e q u a t e . O nt h eo t h e r h a n d , if such a process is not in place, any submission of false
24 25
Market Behavior Rule Order, 105 FERC 61,218 at App. A.
This specific due diligence standard was established before the Commission adopted the more broadly applicable Enforcement Policy Statement.
26 27 28
See Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 70. Enforcement Policy Statement, 113 FERC 61,068 at PP 22-26.
See also Chapter 1, discussing how background checks of traders may help to develop a d e f e n s e a g a i n s t e n f o r c e m e n t a c t i o n s r e s u l t i n g f r o ma c t i v i t i e s o f a r o g u e t r a d e r . Market Behavior Rule Order, 105 FERC 61,218 at P 66; see also Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 69. The due diligence and intent standard of Rule 2(b), 2(c) and Rule 3 is currently the subject of appeal in the D.C. Circuit.
29
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information is presumed to be intentional, even if the submitting employee did not know it was false.30 3. Rule 2(c) Artificial Congestion R u l e 2 ( c ) p r o h i b i t s t r a n s a c t i o n s i nw h i c ha ne n t i t yf i r s t creates artificial congestion and then purports to relieve such artificial congestion (unless Seller exercised due diligence 31 to prevent such occurrence). This Rule applies to two related acts, involving, first, the artificial creation of real or perceiv e dc o n g e s t i o na n d , s e c o n d , a ne f f o r t t o r e l i e v e t h a t congestion in exchange for a payment or compensation of some sort. Under Rule 2(c), artificial congestion includes any form of congestion that may result from scheduling power flows in an uneconomic (or physically impossible) manner for the purpose of creating either real or perceived congestion. For example, intentionally scheduling power over a line known to be out-of-service or known to have insufficient capacity to transmit the scheduled power would most likely fall under Rule 2(c).32 Similarly, scheduling power that is never expected to flow is also apparently a violation of Rule 2(c).33 Rule 2(c) incorporates an intent standard similar to Rule 2(b) that allows an entity (i.e., the seller) to protect itself from liability by establishing scheduling procedures that are reasonably designed to prevent the prohibited conduct or render it inadvertent. FERC has indicated that, whereas the conduct itself and the facts and circumstances of the market as a whole may be used to infer intent and establish a prima facie case of violation, the seller can rebut the presumption of intent if it has adequately exercised due diligence to prevent the occurrence.34 In response to requests for rehearing and clarification, FERC noted that if a seller can establish that there was a legitimate business purpose to justify scheduling procedures that
30 31 32
Market Behavior Rule Order, 105 FERC 61,218 at P 66. Id. at App. A.
As discussed in a FERC Staff report on market manipulation in western energy markets, t h e f i r s t i n s t a n c e o f t h e s e [ c o n g e s t i o n ] t r a d i n gs t r a t e g i e s o c c u r r e do nMa y2 5 , 1 9 9 9 .O nt h a t d a y , Enron scheduled an infeasible transaction in the Cal PX market across an intertie between southern California and Nevada. Because this schedule called for 2900 MW to go across a line with only 15 MW of available capacity, it triggered the Cal ISO's congestion management procedures. A later investigation i n t o t h i s b y t h e C a l P Xr e s u l t e di n a c a s h s e t t l e m e n t b y E n r o n . Final Report on Price Manipulation in Western Markets, Docket No. PA02-2-000, at VI-2 6 ( Ma r . 2 0 0 3 ) ( We s t e r n Ma r k e t s R e p o r t ) .N o t e t h a t t h i s i n c i d e n t o c c u r r e dp r i o r t ot h e i s s u a n c eo f t h e Market Behavior Rules, and was cited as a justification for the rules. Market Behavior Rule Order , 105 FERC 61,218 at P 1. F E R Ch a si n d i c a t e di ns e v e r a l o r d e r st h a t t h e D e a t hS t a r s t r a t e g y( a l s ok n o w na s circular scheduling), where equal amounts of power are scheduled to flow in opposite directions, canceling each other out but meriting a congestion relief payment, is unlawful market manipulation, but that has been challenged by other parties.
33
Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 82; see also Enforcement Policy Statement, 113 FERC 61,068 (listing factors FERC will consider in evaluating violations and imposing penalties).
34
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otherwise would violate Rule 2(c), it could avoid liability. However, FERC indicated that a b s e n t u n e x p e c t e dc o n g e s t i o nw h i c hcomes about in the dynamic operation of the power grid, [it] would not expect to discover many, if any, legitimate business purposes associated 35 w i t h s u c h a c t i v i t y . 4. Rule 2(d) Collusive Acts R u l e2 ( d ) p r o h i b i t s c o l l u s i o nw i t ha n o t h e r p a r t yf o r t h ep u r p ose of manipulating market prices, market conditions, or market rules for electric energy or electricity 36 p r o d u c t s . This prohibition is not limited to acts that may affect market prices, but also extends to acts that may affect market conditions and market rules.37 It is also not limited to c o l l u s i o n a sthat term derives from antitrust law. FERC explained that its authority to adopt this provision arises from its responsibilities under the FPA to ensure that all jurisdictional rates and charges and all rules and regulations affecting such rates and charges are just and reasonable.38 It further explained t h a tw h i l ei t sd e f i n i t i o no f c o l l u s i o n incorporates elements of antitrust law, it also could encompass other joint activities, such as formal or infor m a l p a r t n e r s h i p s t h a t a r en o t s u b j e c t t oa n t i t r u s t j u r i s p r u d e n c e , b u t t h a t could give rise to manipulative schemes.39 Finally, FERC noted that Rule 2(d) does not 40 a p p l yt oa c t i o n s o r t r a n s a c t i o n s t h a t h a v e a l e g i t i m a t e b u s i n e s s p u r p o s e , but it otherwise has declined to specify with any particularity the behavioral elements that may be found to 41 c o n s t i t u t e c o l l u s i o n . 5. Significant Identified Uncertainties in Interpretation of Rule 2 Perhaps the most difficult compliance issue arising out of Rule 2 relates to the generic l a n g u a g e i nt h e R u l e s p r e a m b l e t h a t p r o h i b i t s a l l a c t i o n s o r t r a n s a c t i o n s t h a t a r e w i t h o u t a legitimate business purpose and that are intended to or foreseeably could manipulate market prices, market conditions, or market rules for ele c t r i ce n e r g yo r e l e c t r i c i t yp r o d u c t s ( t h e 42 g e n e r i ca n t i -m a n i p u l a t i o nr u l e ) . The generic anti-manipulation rule is intentionally vague, and FERC has indicated that it intends to use the rule to prohibit any and all types of
35 36 37 38 39 40 41
Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 81. Market Behavior Rule Order, 105 FERC 61,218 at App. A. Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 90. Market Behavior Rule Order, 105 FERC 61,218 at P 89. Id. Id. at P 91.
Although an explicit agreement to engage in conduct that violates the rules is no doubt prohibited, it is less clear whether parallel behavior without such an explicit agreement is prohibited. Parties involved in the California market crisis of 2000-2001 have argued that parallel behavior should be viewed as manipulative, but there are no cases where FERC has penalized mere parallel behavior.
42
Market Behavior Rule Order, 105 FERC 61,218 at App. A.
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activities that it may, in the future, deem manipulative.43 In attempting to clarify the rule, but n o t l i m i t i t s f u t u r e f l e x i b i l i t y , F E R Ch a s d e f i n e d l e g i t i m a t e b u s i n e s s p u r p o s e w i t he q u a l l y v a g u el a n g u a g e , s u c ha sa c t i o n s t h a t a r e c o n s i s t e n t w i t ht h es e l l e r s a u t h o r i z e db u s i n e s s 44 a c t i v i t i e s and behavior that was undertaken to provide service to a buyer with rates, 45 terms, and conditions disciplined by the competitive forces of the market. Although the l e g i t i m a t eb u s i n e s sp u r p o s e d e f e n s ea l s oe x i s t si na n t i t r u s t l a w , i t i sn o t clear whether FERC's use of that term will mirror antitrust jurisprudence. I na d d i t i o nt ou n c e r t a i n t i e s a b o u t w h a t c o n s t i t u t e s a l e g i t i m a t eb u s i n e s s p u r p o s e , t h e w o r d s i n t e n d e dt oo r f o r e s e e a b l yc o u l dm a n i p u l a t e m a r k e t p r i c e s , m a r k e t c o n d i t i o n s o r ma r k e t r u l e s a r e d e s i g n e dt oa l l o wF E R Ct oe x a m i n ea l l r e l e v a n t f a c t s a n dc i r c u m s t a n c e s surrounding the activity to establish its purpose and intended result. This may work in favor of a seller in terms of requiring some objective standard of intent or foreseeability, but any a d v a n t a g e m a yb e o f f s e t b y t h e b r e a d t ho f t h e w o r d s m a r k e t p r i c e s , m a r k e t c o n d i t i o n s a n d m a r k e t r u l e s a n d t h e l a c k o f s p e c i f i c d e f i n i t i o n o f m a n i p u l a t i o n . In the end, the only truly reliable safe harbor is for actions or transactions that are expressly approved by FERC rules, orders, or tariffs. Another approach, however, is to request an informal n o -a c t i o nl e t t e r pursuant to the recently-announced FERC policy 46 statement. A l t h o u g ht h e no-acti o n letters are not binding on the Commission, they do represent Commission Staff's recommendation and reasoning relative to a request for advice on a specifically identified transaction or type of transaction. If FERC and Staff follow through on this no-action letter approach, it could add valuable certainty, though it is unclear what time frame will be required to obtain such guidance. In designing a compliance program to address the generic anti-manipulation rule, companies will have to make individual decisions about the restrictions and guidelines they put in place for their traders. Some companies may want to be very conservative and request no-action letters or other guidance from FERC for each new type of trade or strategy that seems to fall in a gray area. This approach also m a yr e q u i r em a k i n gp u b l i cac o m p a n y s proprietary and competitive business strategies, and may, if broadly used throughout the industry, slow down the development of creative, market-responsive products and services. If pre-approval is not sought, companies would be well-advised to establish processes that (i) require approval from officers or directors for new trading strategies, (ii) analyze each such s t r a t e g yt od e t e r m i n ew h e t h e r a l e g i t i m a t eb u s i n e s s p u r p o s e i sbehind it, and (iii) if the strategy is to be pursued, document the business justification internally before the strategy is taken to market. It may be helpful to include economic advisors in this effort to help flesh out different perspectives on specific potential strategies.
Id. at PP 168-69. development.

44 45 46
43
The scope of this rule thus is uncertain and subject to future
Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 37. Market Behavior Rule Order, 105 FERC 61,218 at P 42. No-Action Letter Process Order, 113 FERC 61,174.
MARKET BEHAVIOR RULES C. MARKET BEHAVIOR RULES 3 (COMMUNICATIONS) AND 4 (REPORTING)
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Ma r k e t B e h a v i o r R u l e 3 ( R u l e 3 ) a n dMa r k e t B e h a v i o r R u l e 4 ( R u l e 4 ) r e l a t e t o communications and reporting of operations and trade information and are similar in nature, albeit with one important distinction. Rule 3 requires sellers to exercise due diligence in any communication with the Commission, Commission-approved market monitors, Commissionapproved regional transmission organizations, or Commission-approved independent system operators, or jurisdictional transmission providers, to: provide accurate and factual information; not submit false or misleading information; not omit material information. To the extent a seller engages in reporting of transactions to publishers of electricity or natural gas price indices, Rule 4 requires the seller to: provide accurate and factual information; not knowingly submit false or misleading information; not knowingly omit material information; report its transactions in a manner consistent with the procedures set forth in Price Discovery in Natural Gas and Electric Markets, Docket No. PL03-3, as clarified over time; notify the Commission of whether it engages in reporting of transactions and update the Commission within 15 days of any subsequent change to its transaction reporting status; and adhere to such other standards and requirements for price reporting as the Commission may order, e.g., if the Commission were to order a mandatory reporting requirement in the future. The due diligence standard in Rule 3 is similar to that under Rules 2(b) and 2(c) in that it would allow a seller with a comprehensive compliance program to establish a rebuttable presumption that it did not knowingly or intentionally engage in the submission of false, inaccurate or incomplete information. Conversely, the absence of internal efforts designed to assure submission of accurate and complete information could bear on a defendant's culpability (or on the appropriate remedy). In response to requests for rehearing, FERC expressly refused to incorporate an explicit intent requirement into Rule 3.47
47
Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 96.
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FERC has not provided a due diligence defense for Rule 4, but did state that violation of Rule 4 would require that any submission of false or inaccurate information or any omission of material i n f o r m a t i o nb e k n o w i n g ; o t h e r w i s et h es e l l e rw o u l dn o tb ei n v i o l a t i o no f t h e R u l e .A l t h o u g hF E R Ch a s n o t e l a b o r a t e do nt h e k n o w i n g s t a n d a r d , i t i s possible that FERC would view an adequate compliance program as relevant to whether a violation occurred and, if so, the severity of any associated remedies or penalties. Such a program, as discussed in more detail in Chapter 1, would, among other things, educate employees on the rules and help ensure adequate supervision of reported information. Also in response to requests for rehearing, FERC declined to specify what might be a m a t e r i a l o m i s s i o n i n R u l e 3 . I n s t e a d , i t s t a t e d t h a t w h i l e m a t e r i a l i t y may not be given to a precise before-the-fact definition in every case, we believe the seller will have sufficient notice regarding the requirements of our rule. First, materiality can be established with sufficient particularity by the seller by reference to Commission-approved rules and industry practices. In addition, sellers will be accorded a safe harbor under our rule to allow for reasonable, unforeseen differences regarding the meaning of our requirement as it may be applied, i.e., our rule will not be applied against a seller shown to have exercised due diligence.48 D. MARKET BEHAVIOR RULE 5 RECORD RETENTION Ma r k e t B e h a v i o r R u l e 5( R u l e 5 ) r e q u i r e s t h a t s e l l e r s r e t a i n , f o r a p e r i o do f t h r e e years, all data and information (including contractual and related documentation) upon which it billed the prices it charged for electric energy or electric energy products it sold pursuant to its market-based rate tariff or the prices it reported for use in price indices. 49 This requirement includes all such documentation, regardless of the medium (e.g., contract, email, voice recording, or other), and regardless of the extent to which the information at issue was relied upon. FERC clarified that the information required to be retained does not include cost-ofservice data or analytical data relating to revenues and expenses for all market-based rate sales, rathe r i t r e l a t e s t ot h e c o m p l e t es e t o f c o n t r a c t u a l a n dr e l a t e dd o c u m e n t a t i o nu p o n 50 w h i c h [ s e l l e r s ] b i l l e d t h e i r c u s t o m e r s . In so holding, FERC rejected arguments that costof-service information was necessary to calculate disgorgement remedies in the future.
48 49 50
Id. at P 95. Market Behavior Rule Order, 105 FERC 61,218 at App. A. Id. at P 124; see also Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at
P 108.
MARKET BEHAVIOR RULES E. MARKET BEHAVIOR RULE 6 RELATED TARIFFS
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Ma r k e t B e h a v i o r R u l e 6 ( R u l e 6 ) p r o h i b i t s s e l l e r s f r o mv i o l a t i n g o r c o l l u d i n gw i t h another party in actions that violate their Codes of Conduct51 under market-base rate tariffs or the Standards of Conduct, as they may be revised from time to time.52 FERC noted that in its Western Markets Report, Staff had found violations of provisions of s e l l e r s Codes and Standards of Conduct requiring, among other things, functional separation of transmission and wholesale marketing personnel. 53 R u l e6 w a sa d o p t e dt oe m p h a s i z eF E R C s commitment to enforcement of these requirements and to subject violators and their affiliates54 to disgorgement of profits or other appropriate remedies under the Market Behavior Rules. FERC noted that it did not intend to penalize all inadvertent or technical errors (such as failure to post a job description), but that it was concerned with all violations, particularly those involving preferential affiliate dealings.55 III. REMEDIES AND COMPLAINT PROCEDURES
The Market Behavior Rules are enforceable either upon FERC so w nm o t i o no r 56 through the filing of a complaint by a third party under the following procedures: Complaints must be filed no more than 90 days after the end of the calendar quarter in which the violation is alleged to have occurred, or from the time when the market participant knew or should have known of the behavior, whichever is later. The Commission will act within 90 days from the date it knew of an alleged violation of its Market Behavior Rules or knew of the potentially manipulative character of an action or transaction, whichever is later. Knowledge on the part of t h eC o m m i s s i o nw o u l dt a k et h ef o r mo f ac a l l t oF E R C s E n f o r c e m e n t H o t l i n e alleging inappropriate behavior, or communication with enforcement Staff. Allegations of violations subject to the disgorgement remedy must be made on a transaction-specific basis.
51 52
Code of Conduct requirements are discussed in Chapter 11 of this Handbook.
Market Behavior Rule Order, 105 FERC 61,218 at App. A. While the reference in the Market Behavior Rules is to the Order No. 889 Standards of Conduct, presumably the requirement applies as well to the successor Standards of Conduct developed under Order No. 2004, et al., and discussed in Chapter 10 of this Handbook.
53 54
Market Behavior Rule Order, 105 FERC 61,218 at P 126.
For example, affiliates of Transmission Providers who do not also own or operate jurisdictional transmission facilities arguably are not directly subject to the Standards of Conduct. Rule 6 now makes collusion with a Transmission Provider to cause that Transmission Provider to v i o l a t e t h e S t a n d a r d s o f C o n d u c t a v i o l a t i o n o f e a c h s e l l e r s m a r k e t -based rate tariff, subject to all the penalties of the Market Behavior Rules.
55 56
Market Behavior Rule Order, 105 FERC 61,218 at P 130. Id. at App. B.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK The complainant carries the burden of proof regarding the facts and law asserted.
A. SIGNIFICANT UNCERTAINTIES IN THE COMPLAINT PROCEDURE I t w i l l b ev e r yd i f f i c u l t f o rs e l l e r st oa s c e r t a i nw h e nF E R Cf i r s t k n e w a b o u t a potentially manipulative action or transaction. Unless the hotline and enforcement Staff is required to keep detailed logs of every contact, and unless a respondent has access to all such confidential logs, it is not clear how a respondent could prove the date that FERC became aware of an incident. S i m i l a r l y , t h e k n e wo r s h o u l dh a v e k n o w n s t a n d a r d f o r t h e b r i n g i n go f a c o m p l a i n t by a third party after the end of the ninety-day period will be difficult to apply. FERC indicated that an objective standard will be used to judge the timeliness of a complaint; i.e., w h e na r e a s o n a b l ep e r s o ne x e r c i s i n gd u ed i l i g e n c es h o u l dh a v ek n o w no ft h ea l l e g e d 57 wrong f u l c o n d u c t . Thus, any complaint filed after the ninety-day period will have to make a showing that the complainant did not and could not reasonably have known about alleged misconduct,58 and this will likely always be an issue to be decided in the proceeding itself. Thus, from a compliance standpoint, the potential liability is rather open-ended from the commencement of the transaction until a final decision in a complaint proceeding is reached. Another uncertainty arising out of the market behavior rule procedure is the definition o f a t r a n s a c t i o n -s p e c i f i c c o m p l a i n t a n dw h e nt h a t r e q u i r e m e n t w o u l dh a v et ob em e t , although, on the surface, FERC appears to have required the specificity to be built into the complaint itself.59 I nd e f i n i n g t r a n s a c t i o n -s p e c i f i c , F E R Cs t a t e st h a t i t r e f e r r e dt ot h e 60 s p e c i f i c t r a n s a c t i o n s w h i c h a r e t h e s u b j e c t o f t h e s e c o m p l a i n t s . Otherwise, it gives little guidance as to what flexibility it will afford complainants to conduct discovery once a complaint has been initiated and to add counts to the complaint or even file a new complaint if additional alleged violations are uncovered during discovery. In adopting the transactionspecific requirement, it seems likely that, at a minimum, FERC wanted to ensure that the tariff violation procedure it was adopting in these rules did not become the vehicle to commence an industry-wide or market-wide generic procedure, such as the refund proceeding in California.61 It remains to be seen how this requirement actually will be implemented. The question of who bears the burden of proof in a FERC-initiated investigation is also less than clear. Normally FPA section 206 requires that a complainant or FERC, initiating an investigation on its own motion, bears the burden of proof. FERC has clarified
57
Id. at P 147; see also Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 148. See 18 C.F.R. 385.206 (2005) (setting forth requirements for filing of complaints). June 26 Order, 103 FERC 61,349 at P 38. San Diego Gas & Elec. Co. v. Sellers of Energy & Ancillary Servs., Docket No. EL00-95.
P 148.
58 59 60 61
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that it will require a complainant to bear this burden regarding both the facts and the law,62 but it did not answer the question as regards its own investigations, which are, pursuant to these rules, in the nature of an enforcement action of tariff conditions approved under FPA section 205. In the case of some of the rules, it appears that FERC would require the tariff holder to bear the burden of proving, for example, that it had a legitimate business purpose or that it had exercised due diligence to prevent the occurrence of the alleged misconduct. B. TYPES OF REMEDIES Any violation of the Market Behavior Rules would constitute a violation of the s e l l e r s f i l e dm a r k e t -based rate tariff63 and potentially would be subject to the same penalties as would any other tariff violation, including loss of market-based rate authorization or, pursuant to EPAct 2005, civil penalties. 64 One such remedy, assuming the timely filing of a complaint or initiation of a proceeding by FERC, would be a requirement that the seller disgorge all profits associated with the transaction from the date the transaction first occurred65 (albeit not earlier than the effective date of the rules). In addition, FERC has declared that a seller violating the Market Behavior Rules couldb es u b j e c t t oo t h e r n o n monetary remedies,such as generic rule changes or the approval of new market rules applicable to specific markets.66 When exercising its discretion to determine the appropriate remedy for a violation, FERC will take into account f a c t o r s s u c ha s h o ws e l f e v i d e n t t h e v i o l a t i o ni s a n dw h e t h e r 67 s u c hv i o l a t i o ni sp a r t o f ap a t t e r no f m a n i p u l a t i v eb e h a v i o r . These considerations are similar to those identified in the Enforcement Policy Statement and the Federal Sentencing Guidelines discussed in Chapter 1. C. SIGNIFICANT UNCERTAINTIES IN IMPLEMENTATION OF REMEDIES It is unclear how or if FERC intends to establish a cost-based benchmark that could b e u s e d t o c a l c u l a t e u n j u s t p r o f i t s f o r p u r p o s e s o f d i s g o r g e m e n t .T h i s u n c e r t a i n t y p e r t ains b o t ht o p r o f i t s d e r i v e df r o mt h es e l l e r ' s o w ng e n e r a t i o n( w h e r e t h ei s s u ew o u l dr e l a t et o which unit-specific costs would be recoverable and which revenues would be deemed p r o f i t , a s w e l l a s to situations where the seller has purchased energy for resale and the sale i s m a d ef r o mi t s p o r t f o l i o ) .I t i s still less clear if FERC would consider a market-based disgorgement remedy, and, if so, on what basis such remedy would be calculated.68 In
62 63 64 65 66 67 68
Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 150. Market Behavior Rule Order, 105 FERC 61,218 at App. A. See Chapter 3 for a discussion of penalties. Market Behavior Rule Order, 105 FERC 61,218 at App. A. Id. at P 149. Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 134.
In its consideration of a market-wide remedy to redress a period of unjust and unreasonable rates, FERC required that mitigated market clearing prices be calculated as a proxy to reflect what the market prices should have been, absent severe dysfunctions. See San Diego Gas &
146
response to inquiries about the infeasibility or impracticality of calculating disgorgement amounts, FERC has indicated only that these questions are speculative and that it will evaluate such concerns on a case-by-case basis as they may arise in the future.69 Another uncertainty caused by the disgorgement remedy i s t h e r i p p l e e f f e c t t h a t i t might have on collateral transactions. For example, if an underlying transaction is found to be manipulative, how far down the chain of ensuing transactions will the profit be traced? May subsequent transactions be voided? Questions like this remain unanswered. It is unclear how the Commission will enforce a disgorgement remedy for a violation o f t h e r u l e s t h a t d i d n o t r e s u l t i n p r o f i t s . F o r e x a m p l e , w a s h t r a d e s a r e a per se violation of the rules that, by their nature, d o n o t r e s u l t i n a d i r e c t t r a n s a c t i o n -s p e c i f i c p r o f i t . H o w e v e r , if the result of a wash trade is to raise the market price, it could result in overall increased profits to the seller which could be very difficult to quantify. Other types of activities where it would be difficult to identify and/or quantify transaction-specific profits (or even quantify overall profit impact) could involve instances of misreporting or false submission of information. It seems likely that, in these instances, FERC will use its new civil penalty authority to fashion an appropriate remedy. It also is unclear to whom a disgorgement remedy, once calculated, will be paid. Will it be refunded only to the immediate buyer or will it somehow be allocated to the market as a whole ?T h e a n s w e r m a y d e p e n d o n w h e t h e r t h e b u y e r w a s a n o r g a n i z e d m a r k e t , s u c h a s i n a nR T O , o r w h e t h e r t h e b u y e r w a s a ni n d i v i d u a l e n t i t y .I nF E R C s g a m i n gi n v e s t i g a t i o n s , the settlements between the alleged wrongdoer and Commission Staff involved payments of all the profits derived from the alleged gaming transactions, but those dollars are to be paid into a general, FERC-established account, the allocation of which is to be decided at a later date.70 The standards and methodologies ultimately adopted by FERC to determine who receives refunds of disgorgement amounts and how they are to be allocated will be an important factor in assessing the risk that these rules impose on sellers and who may be likely complainants in the future. IV. COMPLIANCE RECOMMENDATIONS
The relatively open-ended compliance risks arising out of the Market Behavior Rules will be of particular concern to companies with active trading operations or those that engage in innovative or aggressive trading practices,71 although they apply to all sellers making sales
Elec. Co. v. Sellers of Energy & Ancillary Servs., Docket No. EL00-95. Nonetheless, as noted above, FERC has determined not t ou s e m a k e -the-market-w h o l e r e m e d i e s a s ac u r e f o r violation of the Market Behavior Rules. See Market Behavior Rule Order, 105 FERC 61,218 at P 151; Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 131.
69 70
Market Behavior Rule Order on Rehearing, 107 FERC 61,175 at P 130.
See, e.g., Agreement and Stipulation submitted by American Electric Power Corp. in Docket No. EL03-137 3.2 (Aug. 26, 2003). FERC does not want to discourage innovation. See Market Behavior Rule Order, 105 FERC 61,218, concurring opinion of Commissioner Brownell at P 2.
71
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under market-based rate tariffs. Therefore, even companies that are less active in power markets need to understand the rules to help them, among other things, watch for indications that they are being made party to the manipulative practices of another company. Prior to establishing an ongoing compliance program, if it has not already done so, a company may want to inventory current trading practices to ensure that they are not currently engaging in practices similar to the practices popularized in California under names such as Death Star and now expressly prohibited by the Market Behavior Rules. As part of this review, the company should ascertain that its existing practices are consistent with the new rules. After assuring itself that its current practices are supportable under the new rules, a company should then develop a forward-looking means to identify new trading strategies and to review them for consistency with the rules before such strategies are put into practice. Among other things, this may involve development of a formal internal procedure for authorizing new trading practices, and include training of affected employees and officers. Some specific suggestions for inclusion in a compliance program are as follows: Develop and maintain an up-to-date catalogue of the applicable rules for generation unit operations for each market in which generation units are located and into which they sell. Supplement this catalogue with comments, interpretations and case law precedent as such develop and are issued over time. Develop and maintain an up-to-date catalogue of the applicable bid rules for each market in which the company buys or sells electric energy or electric capacity or provides other electric products and services. Supplement this catalogue with comments, interpretations and case law precedent as such develop and are issued over time. Develop a process to review and pre-approve new bidding and trading strategies. Establish contacts, relationships and dialogue with market operators with a goal of u s i n gt h e s ec o n t a c t s a n dd i s c u s s i o n s a s a n e a r l ya l e r t s y s t e mt oi d e n t i f ya n d hopefully resolve potential conflicts and disagreements before they become a problem. Recognize that knowledge and expertise of operational and bidding rules of each organized market in which the company operates is not simply a source of business value. Rather, it has become a compliance requirement and merits r o u t i n et r a i n i n g , a u d i t sa n do t h e rf e a t u r e st h a t c o m p r i s et h ec o m p a n y so t h e r compliance programs. In addition, there should be a designated, qualified company official who is available to answer questions about interpretation of the rules or who can contact outside experts. In the absence of ISO or RTO rules, consider developing and implementing internal guidelines, both with respect to physical withholding (e.g., outage
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK scheduling guidelines, documentation of reasons for forced or unplanned outages, prior notice to market operators, etc.) and economic withholding (e.g., transactional guidelines, securing prior approval from market monitoring units for innovative bidding structures, etc.). (See definitions of physical and economic withholding in section II.A. of this chapter.) D e v e l o p as e to fg u i d e l i n e sa st ow h a tc o n s t i t u t e sa l e g i t i m a t e business 72 p u r p o s e . Consider annotating each trade with its business purpose.73 Develop a set of guidelines and principles to govern the reporting of information to trade indices and the submission of data and other information to FERC, market monitoring units, market operators and jurisdictional transmission providers. Conduct periodic audits to ensure compliance and remedy noncompliance immediately. Identify the information and documentation that is required to be retained under Rule 5. Incorporate th e s er e q u i r e m e n t s i n t ot h ec o m p a n y s d o c u m e n t r e t e n t i o n program. Develop a procedure for identifying new types of information generated within the company that may be subject to Rules 3, 4 or 5, particularly as new trading practices are implemented and as new information systems are developed. Document each of the due diligence processes of the compliance program and make those processes available to all employees on a website or through some similar mechanism. Ensure that all appropriate employees receive training in the Standards of Conduct and Codes of Conduct. Note that it may be necessary to expand training on the Standards of Conduct to Transmission Provider affiliates who potentially could be subject to collusion charges under Rule 6. Review the co m p a n y s p r o c e d u r e s f o r c o m p l y i n gw i t ht h e S t a n d a r d s o f C o n d u c t and Codes of Conduct to ensure that they are sufficiently comprehensive to comply with the requirements of the Market Behavior Rules.
N o t e t h a t m a x i m i z i n g p r o f i t s i s n o t c o n s i d e r e d a l e g i t i m a t e b u s i n e s s p u r p o s e . J u n e 2 6 Order, 103 FERC 61,349 at P 23 n.19.

72
F E R C s s t a t e m e n t s s u g g e s t t h a t s e l l e r s s h o u l dm a i n t a i n r e c o r d s t od e m o n s t r a t e t h a t e a c h transaction (or class of transactions): (i) has economic substance (that is, a seller offers or provides service to a willing buyer, and value is exchanged for value) (see Market Behavior Rule Order, 105 FERC 61,218 at P 37), and (ii) could not foreseeably manipulate market prices, market conditions or market rules. (See id. at P 42.) We recognize that in the fast-paced real-time trading world, this may not be practical. However, to the extent it can be done, it would be an indicator of diligence and good faith effort to comply with the rules.
73
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Review the company s prior track record in terms of prior instances where its trading patterns have been suspect or the subject of an investigation. Assess the o v e r a l l c o m p l i a n c ec u l t u r e w i t h i nt h eo r g a n i z a t i o na si t i sv i e w e db ym a r k e t monitoring units and regulatory staff with oversight for enforcement issues. To the extent that the results of these reviews reveal an unsatisfactory track record or reputation, take proactive steps to work with the external entities to improve and s t r e n g t h e n b o t h t h e c o m p l i a n c e p r o g r a ma n d t h e c o m p a n y s r e p u t a t i o n . Develop, and apply on a consistent basis, consequences or penalties for employees who inadvertently, negligently, or intentionally disregard the c o m p a n y sc o m p l i a n c ep r o g r a m a n di t sd u ed i l i g e n c ep r o c e s s e s . T h e s e consequences or penalties can range from additional training requirements for inadvertent violation to dismissal for continuous or willful violation. This e l e m e n t o f ac o m p l i a n c ep r o g r a ms h o u l db ep a r t o f a ne m p l o y e e sp e r s o n n e l record, so as to support the appropriate corrective action, when and as needed. These steps will not eliminate all compliance risk. As described above, the compliance risk imposed by the Market Behavior Rules is both significant and difficult to manage. However, these or similar steps undertaken with adequate training, monitoring, and enforcement actions as described in Chapter 1 should help to p r o v i d e a u t i l i t y w i t ha g o o d f a i t h e f f o r t d e f e n s e a g a i n s t a n y s u b s e q u e n t e n f o r c e m e n t a c t i o n .
Chapter 10 Standards of Conduct for Transmission Providers

NOEL SYMONS OVERVIEW Perhaps the primary reason that t h e F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n ( FERC o rt h e C o m m i s s i o n )has significantly stepped up its audit program and increased its enforcement staff is to enable it to police compliance with its Standards of Conduct. FERC views these rules as vitally important to its goal of promoting competition, and recent FERC audits have led to numerous settlements in which utilities paid millions of dollars in fines and agreed to significant restructuring of their activities.1 As then-Chairman Wood stated in a discussion of Standards of Conduct compliance at a FERC meeting early in 2005: I t h i n k w e r e i n t e r e s t e di n c o m p l i a n c e , n o t i nt h e g o t c h a s .T h e g o t c h a s w e l l d o , i f w e f i n dt h e m 2 w e l l c e r t a i n l yd ot h a t ; i t s o u r j o b . In a similar vein, Commissioner Brownell declared 3 I ms o r r y f o r t h e g u y s t h a t a r e d u m be n o u g h that don t think they re going to g e t c a u g h t . Since that time, with the enactment of the En e r g yP o l i c yA c t o f 2 0 0 5( EPAct 2005 ) , F E R C sp e n a l a u t h o r i t yh a si n c r e a s e ds i g n i f i c a n t l y ,now permitting imposition of civil penalties of up to $1 million per day per violation.4 But FERC also has announced, through its Enforcement Policy Statement, that it intends to give credit for strong compliance
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Symons has represented over 25 utilities and pipelines on Standards of Conduct, Code of Conduct, and affiliate sales issues. He w a s t h e p r i n c i p a l a u t h o r o f t h e E d i s o nE l e c t r i cI n s t i t u t e s c o m p u t e r -based training on Standards of Conduct now in use by more than 30 companies and 60,000 employees, and represented EEI and others in various capacities in the Order No. 2004 rulemaking sequence. He has spoken on the topic before industry trade groups and at a FERC technical conference, where he first proposed that FERC consider the model of the Federal Sentencing Guidelines as a means to reward utilities for strong compliance programs. He is the author or co-author of several Skadden analyses of the Order No. 2 0 0 4 s e r i e s , a n d o f S k a d d e n s O r d e r N o . 2 0 0 4 c o m p i l a t i o n .
1 2
Recent settlements are discussed further in Part IV, below. Federal Energy Regulatory Commission Open Public Meeting, Jan. 19, 2005, Transcript Id. at 41.
at 40-41.
3 4
16 U.S.C. 825o-1 (2005). As discussed in Chapter 3, it is possible for a single action or practice to result in multiple violations over multiple days. Thus, if such a practice is uncovered in a FERC audit after a long period of implementation, penalties in theory could be quite high.
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programs in the form of reduced penalties for violation of the Standards of Conduct and other FERC requirements.5 The Standards of Conduct are intended to protect competitors of an electric utility (or interstate natural gas pipeline)6 from any attempt to leverage the market power it is presumed t oh a v eo v e r t r a n s m i s s i o nt oa d v a n t a g ei t s o r i t s a f f i l i a t e s t r a n s a c t i o n s .I nF E R C s v i e w , preferential knowledge of the condition of the transmission system would convey a competitive advantage. The rules seek to prevent such advantages by imposing two primary requirements: (1) a restriction on sharing of transmission or customer information with employees engaged in power sales or other competitive functions, and (2) physical and functional separation between such employees and those engaged in Transmission Functions. Each of these might be thought of as an access restriction the first more behavioral in nature, the second more structural. A third set of administrative requirements revolve, for the most part, around these two core requirements. Each of these three sets of rules is addressed in turn below. Conceptually, the rules are intended to prevent Transmission Function employees from sharing, with any other employee of the Transmission Provider7 or its affiliates, information about any transmission system that the employee receiving the information could use to commercial advantage. The inquiry generally is not whether conveyance of such information did or would confer an advantage, or even if it is likely, but rather whether it is conceivable that it could confer an advantage. This frequently means that application of the rules to a particular company will require operational changes that do not appear necessary to give effect to the purpose of the rules in light of the way that company operates. For this reason, compliance with the rules often is not intuitive to many in business roles who are charged with adhering to them. One of the chief compliance challenges, therefore, is to teach managers and employees who must live with the rules every day to think in the absolute terms of a regulator dealing in generalities, rather than in the nuanced terms of a particular business model.
Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforc e m e n t , 1 1 3 F E R C 6 1 , 0 6 8 ( 2 0 0 5 ) ( Enforcement Policy Statement ) . See Chapters 1 and 3 of this Handbook for detailed discussions of the Enforcement Policy Statement. The Standards of Conduct apply to interstate natural gas pipelines as well as to owners and operators of electric transmission. Consistent with the focus of this Handbook on electric matters, this chapter focuses on application of the Standards of Conduct to electric utilities. However, the rules apply in similar fashion to interstate natural gas pipelines, and we have significant experience representing natural gas pipelines on Standards of Conduct matters. T h et e r m T r a n s m i s s i o nP r o v i d e r i n c l u d e sa n yp u b l i cu t i l i t yt h a t o w n s , o p e r a t e s , o r controls facilities for the transmission of electric energy in interstate commerce. 18 C.F.R. 358.3(a)(1)(2005). The Standards do not apply, however, to Transmission Providers that are FERC-a p p r o v e di n d e p e n d e n ts y s t e m o p e r a t o r s( I S O )o rr e g i o n a lt r a n s m i s s i o no r g a n i z a t i o n s ( R T O s ) .Id. 358.1(c). In addition, a public utility transmission owner that (1) participates in a FERC-approved RTO or ISO, (2) does not operate or control its transmission facilities, and (3) has no access to transmission, customer or market information covered by the rules, may request an exemption from the Standards of Conduct. Id.
7 6
STANDARDS OF CONDUCT FOR TRANSMISSION PROVIDERS
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F E R C sc u r r e n tS t a n d ards of Conduct took effect on September 22, 2004. Promulgated under a series of orders that began with Order No. 2004,8 these new rules expand upon, unify and replace the prior set of rules issued under Order No. 889 (applicable to electric utilities)9 and Order No. 497 (applicable to natural gas pipelines). 10 Perhaps the most significant change of the new rules has been their e x p a n s i o nt oc o v e r E n e r g y A f f i l i a t e s , which means, as discussed below, that more affiliates are subject to the rules now than under the previous set of rules. Many companies have sought to comply with the Order No. 2004 rules by making incremental adjustments to their existing compliance programs established under Order Nos. 889 and/or 497. However, given the heightened level of FERC scrutiny of these matters,11 the significant penalties for non-c o m p l i a n c ee v e nb e f o r eF E R C sp e n a la u t h o r i t yw a s markedly expanded, and the emphasis of the Enforcement Policy Statement on strong
Standards of Conduct for Transmission Providers, Order No. 2004, 68 Fed. Reg. 69,134 (Dec. 11, 2003), III FERC Stats. & Regs., Regs. Preambles 3 1 , 1 5 5( 2 0 0 3 ) ( O r d e r N o . 2 0 0 4 ) , order onr e h g , Order No. 2004-A, 69 Fed. Reg. 23,562 (Apr. 29, 2004), III FERC Stats. & Regs., Regs. Preambles 3 1 , 1 6 1( O r d e r N o . 2 0 0 4 -A ) , o r d e r o nr e h g , Order No. 2004-B, 69 Fed. Reg. 48,371 (Aug. 10, 2004), III FERC Stats. & Regs., Regs. Preambles 31,166 ( O r d e r N o . 2 0 0 4 -B ) , o r d e r o nr e h g , Order No. 2004-C, 70 Fed. Reg. 284 (Jan. 4, 2005), III FERC Stats. & Regs., Regs. P r e a m b l e s3 1 , 1 7 2( 2 0 0 4 ) ( O r d e r N o . 2 0 0 4 -C ) , o r d e r o nr e h g , Order No. 2004-D, 110 FERC 61,320 (2005). A compilation of these orders, including a consolidated table of contents, is available from your regular Skadden, Arps contact, or by sending an email to nsymons@skadden.com. Open Access Same-Time Information System (formerly Real-Time Information Networks) and Standards of Conduct, Order No. 889, 61 Fed. Reg. 21,737 (May 10, 1996), FERC Stats. & Regs., Regs. Preambles 1991-1996 3 1 , 0 3 5( 1 9 9 6 ) ( O r d e r No. 8 8 9 ) , o r d e r o nr e h g , Order No. 889-A, 62 Fed. Reg. 12,484 (Mar. 14, 1997), FERC Stats. & Regs., Regs. Preambles 1996- 2000 3 1 , 0 4 9( O r d e r No. 889-A ) , r e h gd e n i e d , Order No. 889-B, 62 Fed. Reg. 64,715 (Dec. 9, 1997), FERC Stats. & Regs., Regs. Preambles 1996-2000 3 1 , 2 5 3 ( 1 9 9 7 ) ( O r d e r No. 889-B ) . Inquiry Into Alleged Anticompetitive Practices Related to Marketing Affiliates of Interstate Pipelines, Order No. 497, 53 Fed. Reg. 22,139 (June 14, 1988), FERC Stats. & Regs., Regs. Preambles 1986-1990 30,820 (1988), o r d e r o n r e h g , Order No. 497-A, 54 Fed. Reg. 52,781 (Dec. 22, 1989), FERC Stats. & Regs., Regs. Preambles 1986-1990 30,868 (1989), order extending sunset date, Order No. 497-B, 55 Fed. Reg. 53,291 (Dec. 28, 1990), FERC Stats. & Regs., Regs. Preambles 1986-1990 30,908 (1990), order extending sunset date, Order No. 497-C, 57 Fed. Reg. 9 (Jan. 2, 1992), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,934 (1991), r e h gd e n i e d , 57 Fed. Reg. 5815 (Feb. 18, 1992), 58 FERC 61,139 (1992); Tenneco Gas v. FERC, 969 F.2d 1187 (D.C. Cir. 1992) (affirmed in part and remanded in part), order on remand and extending sunset date, Order No. 497-D, 57 Fed. Reg. 58,978 (Dec. 14, 1992), FERC Stats. & Regs., Regs. Preambles 19911996 30,958 (1992), o r d e r o n r e h g a n d e x t e n d i n g s u n s e t d a t e , Order No. 497-E, 59 Fed. Reg. 243 (Jan. 4, 1994), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,987 (1993), order denying r e h gand granting clarification, Order No. 497-F, 59 Fed. Reg. 15,336 (Apr. 1, 1994), 66 FERC 61,347, order extending sunset date, Order No. 497-G, 59 Fed. Reg. 32,884 (June 27, 1994), FERC Stats. & Regs. Regs. Preambles 1991-1996 30,996 (1994). At the time of publication, FERC had underway an ambitious program to audit all 190 gas and electric transmission providers. See Chapter 2 of this Handbook for a discussion of FERC audits.
11 10 9 8
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compliance programs, we recommend a full review of Standards of Conduct compliance measures. Below we explain the requirements of FERC's Standards of Conduct, and we point out various uncertainties in interpretation and compliance issues that may arise. In most instances application of the rules is clear. But because the rules apply to literally every employee of a Transmission Provider and some of its affiliates, ambiguities surrounding application to even a relatively small percentage of personnel still can affect a lot of employees, and so can be a significant potential problem. Moreover, some of the most d i f f i c u l t i n t e r p r e t a t i v e i s s u e s p e r t a i n t op e r s o n n e l t h a t a c o m p a n y w i s h e s t o s h a r e b e t w e e n transmission and competitive functions, including senior officers. I. INDEPENDENT FUNCTIONING REQUIREMENT
A. THE BASIC REQUIREMENT T h e b a s i c i n d e p e n d e n t f u n c t i o n i n g r e q u i r e m e n t u n d e r t h e S t a n d a r d s o f C o n d u c t i s that, except in emergency circumstances affecting system reliability, employees engaged in Transmission Functions m u s t o p e r a t ecompletely separately from emplo y e e s o f E n e r g y A f f i l i a t e s a n d Ma r k e t i n gA f f i l i a t e s . ( Ma r k e t i n gA f f i l i a t e s a r ee s s e n t i a l l yas u b s e t o f 12 E n e r g y A f f i l i a t e s . B o t h a r e r e f e r r e d t o h e r e a s E n e r g y A f f i l i a t e s . ) Transmission Function employeem e a n sa nemployee, contractor, consultant or agent of a Transmission Provider who conducts transmission system operations or reliability functions, including, but not limited to, those who are engaged in day-to-day duties and responsibilities for planning, directing, organizing, or carrying out transmission-related operations.13 Most frequently the persons that are considered Transmission Function employees are those that operate the transmission system or sell transmission service. However, the term can have very broad reach. Generally speaking, any person that makes or participates in even a single business decision regarding the transmission system should be evaluated as a possible Transmission Function employee.14
Under the new rules , t h e t e r m Ma r k e t i n gA f f i l i a t e i s d e f i n e da s a nA f f i l i a t e a s t h a t term is defined in 358.3(b) or a unit that engages in marketing, sales or brokering activities as those t e r m sa r ed e f i n e da t 3 5 8 . 3 ( e ) . 1 8C . F . R . 3 5 8 . 3 ( k ) .A n A f f i l i a t e , i nt u r n, is defined as [ a ] n o t h e r p e r s o n w h i c h c o n t r o l s , i s c o n t r o l l e d b y o r i s u n d e r c o m m o n c o n t r o l w i t h , s u c h p e r s o n . Id. 3 5 8 . 3 ( b ) . A n A f f i l i a t e i n c l u d e s a d i v i s i o n t h a t o p e r a t e s a s a f u n c t i o n a l u n i t . . . . Id.
12 13 14
Id. 358.3(j).
See Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 131. Transmission F u n c t i o ne m p l o y e e sm a yb et h o s ew h oe n g a g ei n d a y -to-d a y t r a n s m i s s i o n -related activities, or t h o s e w h o p e r f o r m o n l e s s f r e q u e n t , b u t e q u a l l y a s s i g n i f i c a n t b a s i s , t r a n s m i s s i o n f u n c t i o n s , s u c h as organizing expansion of capacity or deciding on whether to construct an interconnection.
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It is important to emphasize that FERC has defined this function to include persons consultants and contractors who actually are not even technically employees of the Transmission Provider.15 The new rules have expanded the Standards of Conduct to cover all Energy Affiliates of a transmission provider. The new definition potentially requires application of the rules both to business units within the Transmission Provider that were not covered under the prior Standards of Conduct, and to affiliates of the Transmission Provider that were not covered under the prior Standards of Conduct.16 A n affiliatei n c l u d e s a f u n c t i o n a l u n i t o f at r a n s m i s s i o np r o v i d e r , m e a n i n g that, contrary to the ordinary usage of the term, an Energy Affiliate is not necessarily a separate company, but could be (and often is) a business unit of the Transmission Provider in particular, a business unit that buys and sells wholesale electric power.17 Energy Affiliates are those that, in the United States: Engage in or are involved in electric or gas transmission transactions, other than as a Transmission Provider;18 Manage or control transmission, e.g., through the purchase and resale of transmission;19
15 16
18 C.F.R. 358.3(j).
Previously, under Order No. 889, the Standards of Conduct governed the relationship between the Transmission Function of the Transmission Provider and internal business units and affiliates engaged in wholesale merchant activities. As the list of activities that make a business unit or affiliate an Energy Affiliate shows, the rules now reach considerably beyond wholesale merchant activities. See id. 358.3(d).
17 18
Id. 358.3(b)(1).
Id. 358.3(d)(1). In Order No. 2004-A , F E R Ce x p l a i n e dt h a t t h et e r m e n g a g e si n t r a n s m i s s i o nt r a n s a c t i o n sm e a n s t h eA f f i l i a t eh o l d s( o r i sr e q u e s t i n g ) t r a n s m i s s i o nc a p a c i t yo na Transmission Provider as a shipper or customer or buys or sells transmission capacity in the s e c o n d a r y c a p a c i t y m a r k e t . O r d e r N o . 2 0 0 4 -A, III FERC Stats. & Regs. 31,161 at P 44. The term i n v o l v e d i n m e a n s a c t i n g a s a g e n t , a s s e t m a n a g e r , b r o k e r o r i n s o m e f a s h i o n m a n a g i n g , controlling o r a g g r e g a t i n gc a p a c i t yo nb e h a l f o f t r a n s m i s s i o nc u s t o m e r s o r s h i p p e r s . Id. FERC also clarified that other transmission-related interactions between a Transmission Provider and its interconnected Affiliate, such as confirming nominations and schedules with upstream producers and gathering facilities, exchanging operational data relating to interconnection points, and communications relating t o m a i n t e n a n c e o f i n t e r c o n n e c t e d f a c i l i t i e s a r e n o t i n c l u d e d i n t h e d e f i n i t i o n o f t h e t e r m s e n g a g e d i n o r i n v o l v e d i n . Id.
19
18 C.F.R. 358.3(d)(2).
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Buy, sell, trade or administer gas or electric energy (including entities that act as merchants, agents, or asset managers);20 or Engage in financial transactions relating to the sale or transmission of gas or electric energy.21
In this ch a p t e r , w er e f e rt ot h e s ef u n c t i o n st h a t d e f i n ea nE n e r g yA f f i l i a t ea s Energy Affiliate activities. Energy Affiliates do not include: Affiliated Transmission Providers;22 Holding, parent or service companies that do not engage in energy, gas or transmission transactions on their own behalf;23 Affiliates that purchase gas or energy solely for their own consumption;24 State or foreign regulated LDC affiliates that do not make any off-system sales or engage in any Energy Affiliate activities;25 or
20 21
Id. 358.3(d)(3).
Id. This is a significant change from the prior rules. Notwithstanding FERC's past recognition that it lacks direct jurisdiction over financial transactions that do not result in physical delivery of power, see, e.g., Revised Public Utility Filing Requirements, 97 FERC 61,317 (2001) (contrasting FERC's lack of jurisdiction over trading of electricity futures with its jurisdiction over transactions that go to physical delivery), FERC has explained t h a t [ e ] n t i t i e s i n v o l v e di n t h e t r a d i n g of power or gas or in financial transactions related to the sale, purchase or transmission of power or g a s a r e a n i n t e g r a l p a r t o f t h e f i n a n c i a l a n d t r a n s m i s s i o nm a r k e t s . O r d e r N o . 2 0 0 4 , I I I FERC Stats. &R e g s . 3 1 , 1 5 5 a t P4 7 .I t i s p o s s i b l e t h a t a n y d e f i c i e n c y i n F E R C s j u r i s d i c t i o n h a s b e e n c u r e d b y t h e e x p a n s i o n , u n d e r E P A c t 2 0 0 5 , o f F E R C ' s a u t h o r i t y t o a d d r e s s m a r k e t m a n i p u l a t i o n i n c o n n e c t i o n w i t h t h e p u r c h a s e o r s a l e o f e n e r g y o r transmission. 16 U.S.C. 824v. 18 C.F.R. 358.3(d)(6)(i). However, a business unit of an affiliated transmission provider that engages in Energy Affiliate activities would be an Energy Affiliate.
23 24 22
Id. 358.3(d)(6)(iii).
This exception does not i n c l u d e t h e p u r c h a s e o f n a t u r a l g a s o r e n e r g y f o r t h e s u b s e q u e n t g e n e r a t i o n o f e n e r g y . 1 8 C . F . R . 3 5 8 . 3 ( d ) ( 6 ) ( i v ) .F E R Ch a s n o t d i s t i n g u i s h e d b e t w e e ng e n e r a t i o n of electricity for resale and generation of electricity for own consumption, though presumably extending this exemption to generation of electricity for own consumption would be consistent with F E R C s r e a s o n i n g i n c r e a t i n g t h e e x e m p t i o n i n t h e f i r s t p l a c e . Id. 358.3(d)(6)(v). LDCs may participate in financial transactions necessary for price risk management solely for the benefit of on-system retail customers without becoming an Energy Affiliate, but any other such activities will result in Energy Affiliate status. Order No. 2004-C, III FERC Stats. & Regs. 31,172 at P 12.
25
STANDARDS OF CONDUCT FOR TRANSMISSION PROVIDERS Foreign affiliates that do not participate in U.S. markets.26
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The Whole Company Rule. Under the Order No. 889 Standards of Conduct, the Standards of Conduct were applied on the basis of employee function. Under Order No. 2004, that construct has been made the exception rather than the rule. Generally speaking, subject to the refinements discussed below, any affiliate of a Transmission Provider that (a) does not fit one of the exceptions listed above, and (b) employs even a single person engaged in Energy Affiliate activities, is an Energy Affiliate. And every employee of an Energy Affiliate again subject to the refinements discussed below is subject to the independent functioning and information sharing requirements. Thus, because one person performing E n e r g yA f f i l i a t ea c t i v i t i e sc a n t a i n t aw h o l ec o m p a n y , o r aw h o l eb u s i n e s su n i t o f t h e Transmission Provider, we refer to this as the Whole Company Rule. B. REFINEMENTS TO THE BASIC REQUIREMENT 1. Shared Employees FERC has recognized, at least in theory, that a Transmission Provider and its Energy A f f i l i a t e ss h o u l db ep e r m i t t e dt o s h a r e personnel to conduct corporate governance 27 functionsand to take advantage of the efficiencies of corporate integration. Thus, the Standards of Conduct permit the sharing of officers and directors, risk management personnel, support service employees, and field and maintenance employees between a Transmission Provider and its Energy Affiliates in certain circumstances. FERC has warned, however, that shared employees are subject to heightened audit scrutiny,28 and FERC has stated that it will evaluate, in compliance audits and investigations, e m p l o y e e s a c t u a l functions and dutiesto determine whether the Transmission Provider is appropriately applying this exemption. 29 The Title Trap. In a moment, we will discuss the types of personnel that FERC has said may be shared. First, however, we wish to emphasize the most common error associated with shared personnel w e c a l l i t t h e t i t l et r a p . S i m p l yp u t , i t i s w h a t a p e r s o na c t u a l l y 30 d o e s t h a t d e t e r m i n e s s u i t a b i l i t yf o r s h a r e d s t a t u s , n o t t h e p e r s o n s j o bt i t l e . Any person who performs Transmission Functions is ineligible to be shared, regardless of job title. The title trap issue typically arises in situations involving types of employees that may sometimes be shared, such as lawyers. While FERC has not stated it in so many words, we think a good basic rule in such situations is this: If a person engages in business decisions related to the t r a n s m i s s i o ns y s t e m , t h e r ei sag o o dc h a n c et h a t t h ep e r s o n sj o br e s p o n s i b i l i t i e si n c l u d e Transmission Functions. If this proves true upon closer examination, the person cannot be
26 27 28 29 30
18 C.F.R. 358.3(d)(6)(i). Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 121. Order No. 2004, III FERC Stats. & Regs. 31,155 at P 121. Order No. 2004-A, III FERC Stats & Regs. 31,161 at P 134. Order No. 2004-C, III FERC Stats. & Regs. 31,172 at P 30.
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shared.31 An employee, officer or director probably will not qualify for the shared employee exception if he or she: executes or approves power sales agreements;32 executes or approves transmission service or interconnection agreements, or exercises discretion in the administration of the transmission tariff;33 engages in the day-to-day operation of the transmission system;34 or
35 h a s a c c e s s i n h i s o r h e r o f f i c e t o r e a l -t i m e t r a n s m i s s i o n s y s t e md a t a .
Personnel that may be shared without violating the rules if they do not perform Transmission Functions include: Support personnel (including legal, accounting, human resources, travel, and information technology);36 Senior officers and directors (see d i s c u s s i o n b e l o wu n d e r U n c e r t a i n t i e s ) ;37
N o t e , h o w e v e r , t h a t i t i s o f t e n p o s s i b l e t o a m a k e a r e l a t i v e l y m i n o r c h a n g e t o a p e r s o n s job responsibilities to eliminate Transmission Function responsibilities, and hence make the person e l i g i b l e f o r s h a r i n g , i f t h a t i s t h e c o m p a n y s priority.
31
See, e.g., Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 131 (citing Ameren Servs. Co., 87 FERC 61,145, at 61,600 (1999)).
33 34 35
32
Id. Id. See supra note 13 for the definition of Transmission Function employee.
See, e.g., Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 131; see also American Elec. Power Serv. Corp., 81 FERC 61,332, at 62,525-26 (1997). 1 8C . F . R . 3 5 8 . 4 ( a ) ( 4 ) .T h eq u e s t i o no f w h e nl a w y e r s q u a l i f yf o r s h a r i n g i s b e t t e r developed than for other employees or agents, though it still lacks clarity. Generally speaking, it appears that lawyers may provide legal or regulatory advice in their traditional roles without becoming Transmission Function employees, but lose eligibility to be shared if they start making business decisions on behalf of either the Transmission Function or an Energy Affiliate. Unfortunately, however, there is no clear statement to this effect. Instead, the discussion of the role of lawyers often raises more questions than it answers. For example, FERC states that lawyers who h e l pd e v e l o pa n da d v o c a t ep o l i c yi np u b l i cf o r u m sare not necessarily Transmission Function employees. Such advocacy may f a l l w i t h i n t h e l a w y e r s t r a d i t i o n a l r o l e o f p u b l i c l y r e p r e s e n t i n g t h e i r c l i e n t s p o s i t i o n s . O r d e r N o . 2 0 0 4 -B, III FERC Stats. & Regs. 31,166 at P 74 (emphasis added). The dividing line is not clearly stated. The Commission is not mandating separate legal departments o r p h y s i c a l s e p a r a t i o n o f l a w y e r s w i t h i n a l e g a l d e p a r t m e n t , a l t h o u g h either of those measures might s i m p l i f y c o m p l i a n c e . Id. at P 75.
36 37
18 C.F.R. 358.4(a)(5).
STANDARDS OF CONDUCT FOR TRANSMISSION PROVIDERS Field and maintenance personnel, and their immediate supervisors;38 Risk management employees.39
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Uncertainties. There remain significant uncertainties in the interpretation and application of the rules with respect to employee classification. The full list of activities that may result in classification of an employee as Transmission Function or Energy Affiliate is unknown. As stated above, FERC will consider the actual duties and responsibilities of employees, rather than merely job titles, in determining employee classifications. This is beneficial in the sense that it avoids an over-regimented and inflexible system of classification, but it also creates uncertainty. For the most part, the rules on sharing of personnel prohibit such personnel from involvement in Transmission Functions. FERC has not, in most cases, directly addressed whether they may be involved in Energy Affiliate activities. Apparently this was due, in p a r t , t oF E R C s c o n c e r n t h a t i t n o t b e p e r c e i v e da s e x e r c i s i n gj u r i s d i c t i o n o v e r t h e a c t i v i t i e s 40 of some Energy Affiliates that are not jurisdictional. Note, however, that under the Order No. 889 Standards of Conduct, FERC explicitly held that a permissibly shared senior officer c o u l dn o t d i r e c t ,o r g a n i z e ,o re x e c u t e either Transmission Functionso r w h o l e s a l e 41 m e r c h a n t f u n c t i o n s . While FERC did not repeat this particular formulation in Order No. 2004, et al., w h o l e s a l e m e r c h a n t f u n c t i o n s e s s e n t i a l l y w a s t h e p r e c u r s o r t e r mu n d e r O r d e r N o . 8 8 9f o r E n e r g yA f f i l i a t ea c t i v i t i e s , a n di t c o u l db ei m p r u d e n t t oa s s u m et h a t F E R C sought in its new Standards of Conduct to relax requirements imposed under Order No. 889. Classification of senior officers can be particularly difficult, in part because the rules affecting senior officers are ambiguous and at times conflicting. Senior officers and directors may be shared if they do not engage in Transmission Functions, do not have day-to-day (or
T h e r u l e s c o d i f yt h e C o m m i s s i o n s h i s t o r i c a l p o l i c yo f a l l o w i n gT r a n s m i s s i o nP r o v i d e r s to share with their Energy Affiliates field and maintenance personnel who do not take part in advance planning for facility shut downs, or in decisions to shut down facilities for economic reasons. Order No. 2004, III FERC Stats. & Regs. 31,155 at P 105-106; 18 C.F.R. 358.4(a)(4).
38
18 C.F.R. 358.4(a)(6). The responsibilities of such shared risk management employees may include managing corporate-wide business risk exposure, business risk exposure for third parties, managing overall corporate investment, assessing counter-party credit risk (but not the creditworthiness of a transmission customer), approving expansion projects, and establishing spending, trading and capital authorities for each business unit. Order No. 2004, III FERC Stats. & Regs. 31,155 at P 109. However, the rules prohibit the sharing of risk management employees who a r e o p e r a t i n ge m p l o y e e s o f e i t h e r aT r a n s m i s s i o nP r o v i d e r o r i t sE n e r g yA f f i l i a t e s .O r d e r N o . 2004, III FERC Stats. & Regs. 31,155 at P 112. A sat h r e s h o l dm a t t e r , t h eS t a n d a r d so f C o n d u c t a r ei m p o s e d o n l yo nT r a n s m i s s i o n Pr o v i d e r s , n o t Ma r k e t i n go r E n e r g yA f f i l i a t e s t h e m s e l v e s .O r d e r N o . 2 0 0 4 -A, III FERC Stats. & Regs. 31,161 at P 46. To FERC, this distinction is important in light of assertions that it is attempting to exercise jurisdiction over non-jurisdictional activities. Order No. 2004, III FERC Stats. & Regs. 31,155 at PP 88-94.
40 41
39
See American Elec. Power Serv. Corp., 81 FERC 61,332 at 62,513.
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otherwise significant42) responsibilities for planning, directing, organizing or carrying out transmission-r e l a t e do p e r a t i o n s ,a n dd on o ta c ta s c o n d u i t s f o rs h a r i n gt r a n s m i s s i o n , customer or market information with an Energy Affiliate.43 The CEO, CFO or General C o u n s e l o f a c o m p a n y m a y n o t b e c o m e a T r a n s m i s s i o n F u n c t i o n em p l o y e e b y a p p r o v i n g major capital expenditures for transmission, but other officers will. 44 It is less clear what happens when an officer has a role in approving a capital expenditure for construction of generation. Approval or execution by an officer of a power sale contract even if it occurs only rarely apparently means that the officer cannot be shared,45 though it is not clear that this interpretation would apply to the CEO, CFO, or General Counsel, nor is it clear how it could be consistent with the ability of such officers to discharge their fiduciary obligations. Rules governing classification of directors also are fraught with ambiguity. The same rules that apply to officers apply to directors,46 but the interpretive text of the Orders is focused more on application of the rules to officers. Thus, for example, while Order No. 2004-A, as discussed above, appears to recognize some limitations on the application of the rules to the CEO, CFO, and General Counsel, it is unclear whether that same limitation also applies to the directors that oversee their work. Certainly a credible argument could be made that the same interpretation should apply to the directors, but it is only that an argument. 2. Retail Service Employees The rules govern retail personnel in some circumstances, with a distinction made based upon whether the service is provided in a state where retail service remains bundled, or has been unbundled. Employees engaged exclusively in retail sales functions in states where retail service remains bundled (i.e., states without retail open access) are not subject to the rules. 47 In our experience, however, this is a somewhat rare circumstance,
See Order No. 2004-A , I I I F E R CS t a t s . &R e g s . 3 1 , 1 6 1a t P1 3 1( T h e r em a yb e T r a n s m i s s i o n F u n c t i o n E m p l o y e e s w h o d o n o t e n g a g e i n d a y -to-d a y a c t i v i t i e s , b u t a r e p e r f o r m i n g , on less frequent, but equally as significant basis, transmission functions, such as organizing expansion o f c a p a c i t y o r d e c i d i n g o n w h e t h e r t o c o n s t r u c t a n i n t e r c o n n e c t i o n . ) .
42 43 44 45
See id. at PP 135-141. Id. at P 141.
Id. at P 131 and n.88 (citing Ameren Servs. Co., 87 FERC 61,145, at 61,600 (1999)); see also Cinergy Servs., Inc., 111 FERC 61,512, at P 34 (2005). Even execution by an officer of form master enabling agreements means that the officer cannot be shared. Id. at PP 30, 34. See Order No. 2004, III FERC Stats. & Regs. 31,155 at P 135 (discussing application of rule to senior officers and directors). Order No. 2004, III FERC Stats. & Regs. 31,155 at P 78; see also 18 C.F.R. 3 5 8 . 3 ( e ) ( 2 ) ( e x c l u d i n gb u n d l e dr e t a i l s a l e sf r o md e f i n i t i o no f Ma r k e t i n g , s a l e so rb r o k e r i n g ) . FERC lacks jurisdiction over both the transmission and the power sold in a bundled retail product. Promoting Wholesale Competition Through Open Access Non-Discriminatory Transmission Services by Public Utilities and Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Order No. 888, 61 Fed. Reg. 21,540 (May 10, 1996), 1991-1996 FERC Stats. & Regs., Regs.
47 46
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because often employees engaged in bundled retail sales also will be engaged in purchasing power at wholesale, procuring transmission service in support of such purchases, and/or selling excess power at wholesale. Any employee who sells power at wholesale, even if only small amounts left over from retail sales, is an Energy Affiliate employee, absent a waiver.48 It is less clear whether purchases at wholesale in support of bundled retail sales are an Energy Affiliate activity, but there is at least a colorable argument that they are not.49 The rule in a state where the utility provides unbundled retail service is different. Any employee engaged in unbundled retail sales is considered to be engaged in Energy Affiliate activities, and therefore is subject to separation from the Transmission Function.50 o As a practical matter, however, it is unusual for an employee of a utility in a retail open access state to be actively marketing power to r e t a i l c u s t o m e r s .R a t h e r , t h e u t i l i t yu s u a l l yi s c o n s i d e r e da p r o v i d e r o f l a s t r e s o r t , a n dw i l l t y p i c a l l yh a v em a n ye m p l o y e e se n g a g e di n services that, in one form or another, are related to provision of this 51 P O L R s e r v i c e . o FERC has declined to rule generically that any particular POLR services are exempt from classification as Energy Affiliate activities.52 R a t h e r ,u t i l i t i e sa r ei n v i t e dt or e q u e s tf r o mF E R C a w a i v e r o f Standards of Conduct requirements for employees engaged in POLR services, supported by an explanation of why such a waiver is appropriate. In two recent cases FERC either determined that POLR
Preambles 31,036, at 31,689 (1996), o r d e r o nr e h g , Order No. 888-A, 62 Fed. Reg. 12,274 (Mar. 14, 1997), 1991-1996 FERC Stats. & Regs., Regs. Preambles 31,048, at 30,552 (1997), order on r e h g , Order No. 888-B, 81 FERC 61,248 (1997), o r d e ro nr e h g , Order No. 888-C, 82 FERC 61,046 (1998), a f f d i n p a r t , r e m a n d e d i n p a r t s u b n o m . T r a n s m i s s i o n A c c e s s P o l i c y S t u d y G r o u p v . FERC, 225 F.3d 667 (D.C. Cir. 2000), a f f d s u b n o m . N e wY o r k v . F E R C , 535 U.S. 1 (2002).
48 49
Order No. 2004, III FERC Stats. & Regs. 31,155 at P 78.
See Order No. 2004-A, III FERC Stats. & Regs. 31,161 at PP 122-23 (rejecting argument that purchases for native load result in undue preference); Order No. 2004-C, III FERC Stats. & Regs. 31,172 at P 24 and n.9 (quoting Order No. 889-A discussion distinguishing between purchases made solely to serve native load and purchases made in combination with wholesale merchant function).
50 51 52
See generally Order No. 2004-A, III FERC Stats & Regs. 31,161 at PP 124-27. Id. See Order No. 2004-C, III FERC Stats. & Regs. 31,172 at PP 32-36.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK employees are not Energy Affiliate employees, or granted waiver to the same effect.53 3. Holding, Parent or Service Companies
T r e a t m e n t o f A s s i g n e d E m p l o y e e s . As noted above, a holding, parent or service company is not an Energy Affiliate if it does not engage, on its own behalf, in energy, gas or transmission transactions.54 Of course, many such companies do have employees or officers who perform Transmission Functions or Energy Affiliate activities. Typically, however, such employees and officers are assigned in whole or in part to an affiliate or subsidiary company, and perform such activities on behalf of the affiliate or subsidiary to which they are assigned. In such cases, the employee or officer is treated as if they are an employee of the company on whose behalf they perform the activity.55 For example, it is common in a registered holding company system that includes several Transmission Providers for many of the employees who operate the transmission system to be employed by a service company. The utilities themselves may have very few employees. This is, of course, one of the ways that a registered holding company obtains efficiencies, and the Standards of Conduct recognize this by treating only those employees of the services company who perform such functions as Transmission Function employees. 56 More significant is the treatment of service company employees who perform Energy Affili a t e a c t i v i t i e s .O r d i n a r i l y , u n d e r t h e w h o l ec o m p a n y r u l e d i s c u s s e dp r e v i o u s l y , i f a n e m p l o y e ep e r f o r m sE n e r g yA f f i l i a t ea c t i v i t i e s ,t h ee m p l o y e e sc o m p a n yi sa nE n e r g y Affiliate, meaning that everyone else in the company is subject to independent functioning and information sharing restrictions unless they qualify for an exception. Such an impact could be onerous, to say the least, if it applied to a holding, parent or service company. Fortunately, the whole company rule does not apply to such companies. As discussed above, their employees are treated as employees of the companies or business units to which they are assigned. Thus, such companies are considered to be Energy Affiliates only if they conduct Energy Affiliate activities on their own behalf. As Guarantors. Parent and holding companies commonly act as guarantors or provide financial security for their subsidiaries. A parent or holding company may also approve the financial expenditures for its affiliated Transmission Provider. Neither of these activities will result in the parent or holding company being deemed an Energy Affiliate.57
See Cinergy Servs., Inc., 111 FERC 61,512 (2005) (basket order finding that several categories of Cinergy POLR services employees were not Energy Affiliate employees, and granting waiver to same effect for several categories of Exelon POLR services employees).
54 55 56 57 53
See supra note 23. See generally Order No. 2004, III FERC Stats. & Regs. 31,155 at P 57. Id.
Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 100. Note that the issue of approval of an expenditure by a parent or holding company is distinct from the issue of approval of an expenditure by an officer, notwithstanding that the two may in fact be a single act. Approval by the
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However, when a parent or holding company engages in financial transactions that are the functional equivalent of physical transactions in the commodity market,it becomes an Energy Affiliate.58 4. Employee Transfers Employees of the Transmission Provider or its Energy Affiliates are not precluded from transferring between s u c h f u n c t i o n s a s l o n ga s s u c h t r a n s f e r i s n o t u s e d a s a m e a n s t o 59 circumvent the Standards o f C o n d u c t . FERC is more concerned with so-c a l l e d c y c l i n g of employees between the Transmission Provider and its affiliates than it is with a one-time transfer.60 Even a one-time transfer, however, could be a concern if an employee is transferring into a marketing position directly from a position that involved access to transmission information. Such employees should not take up new marketing duties until the 61 i n f o r m a t i o n t h e y p o s s e s s h a s b e c o m e s t a l e . C. COMPLYING WITH THE INDEPENDENT FUNCTIONING REQUIREMENT In our experience, there are a number of common issues that arise in determining whether a company is in compliance with the independent functioning requirement. They include: Are current employee, business unit, and company classifications accurate?
parent or holding com p a n y i s r e l e v a n t t o t h e c o m p a n y s s t a t u s u n d e r t h e S t a n d a r d s o f C o n d u c t , w h i l e t h e o f f i c e r s r o l e i s r e l e v a n t t oh i s o r h e r o w n s t a t u s .B e c a u s e , a s d i s c u s s e d a b o v e , a no f f i c e r c a n b e d e e m e d t o b e a s s i g n e d t o a t r a n s m i s s i o n p r o v i d e r o r E n e r g y A f f i l i a t e by virtue of his or her actions, the officer may have Transmission Function or Energy Affiliate status, while the parent or holding company may not. Id. Under the rules, entities that own a financial interest in transmission facilities, but do not otherwise own, operate or control transmission facilities, are not Transmission Providers. Id. at P 37.
59 60 61 58
Order No. 2004, III FERC Stats. & Regs. 31,155 at P 128. Id. at PP 130-31.
FERC has not been specific as to when transmission information is deemed too stale to raise concerns. However, in an analogous context under the prior Standards of Conduct for interstate natural gas pipelines, FERC approved a consent agreement with Kinder Morgan which provided for a cooling off period during which an employee who transferred from the pipeline to its marketing affiliate would not be permitted to work on the accounts or contracts of the non-affiliated shippers he or she handled at the pipeline. The consent agreement provided that the length of the cooling off period the time frame in which the information loses its commercial value can be determined on a case-by-c a s e b a s i s a n d t h a t , i n g e n e r a l , t h e c o o l i n g o f f p e r i o d w i l l r e a s o n a b l y r e f l e c t t h e t e r m s o f t h e contracts the transferred employee was previou s l yh a n d l i n g . Kinder Morgan Interstate Gas Transmission, LLC, 90 FERC 61,310, at 62,026 (2000). Thus, if the employee was involved with short-term contracts of one month or less, the cooling off period for those contracts would be one month. Id. The longer the contract terms, the longer the cooling off period (again, for the relevant contracts). Id.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Are such classifications based upon an accurate understanding of actual job responsibilities? Are such classifications consistent with developing FERC precedent? Does the company have programs to ensure that employee classifications are accurate and remain up-to-date? What happens if a new employee is hired? Wh a t h a p p e n s i f a n e x i s t i n g e m p l o y e e s j o b r e s p o n s i b i l i t i e s c h a n g e ? How will activities of shared officers, directors and employees be monitored to ensure that they are not engaging in what FERC would deem Transmission Functions or Energy Affiliate activities? How is the company addressing employees engaged in POLR service? Does the company have programs to ensure that company and business division classifications remain accurate and up-to-date? What happens if there is a corporate reorganization? How are new affiliates or subsidiaries handled? What happens when business units are reshaped or their responsibilities are redrawn? What controls are in place to ensure that a non-Energy Affiliate does not inadvertently become an Energy Affiliate?
Evaluation of compliance with the Standards of Conduct can be divided into two p a r t s : ( 1 ) a s n a p s h o t e v a l u a t i o n o f c u r r e n t c o m p l i a n c e , w h i c h w i l l b e p r i m a r i l y s u b s t a n t i v e in nature, and (2) a forward-looking evaluation of programs and systems in place to ensure continued compliance as relevant facts inevitably change. Current Compliance. The central issue in evaluating current compliance with the independent functioning requirement is whether employees, business units, and companies have been properly classified. There is a bit of a chicken-and-egg issue in conducting a review of current compliance, because issues of business unit and individual employee classification are interrelated. We recommend an approach that assumes that current business unit classifications are correct, and begins the inquiry with the classification of individual employees within each business unit. If an employee is improperly classified, the company may choose to change the employee's responsibilities to fit the existing classification, but if the company does not wish to do that it may be necessary to transfer the employee, to reclassify his/her business unit, or even to reshape the business unit.
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In our experience, classif i c a t i o no f c o r e Transmission Function employees those that operate the transmission system i s r a r e l y d i f f i c u l t .T h e s a m e i s t r u e o f c o r e E n e r g y Affiliate employees t h o s ew h os e l l p o w e r o r g a s a t w h o l e s a l e .S o m et y p e s o f s h a r e d employees for example, those who provide information technology services likewise tend to present few classification complications, because the nature of the job position makes it unlikely that the employee would become involved directly in operating the transmission system or in Energy Affiliate activities. More difficult interpretations arise with respect to o t h e r e m p l o y e e s t h e c o m p a n y w i s h e s t od e s i g n a t e a s s h a r e d . I n p a r t i c u l a r , i t often can be difficult to classify: shared officers and directors; employees en g a g e d i n p r o v i d e r o f l a s t r e s o r t s e r v i c e s ; lawyers; employees engaged in resource planning; employees engaged in project development; employees engaged in risk management; employees engaged in rate design; employees engaged in tariff administration; and employees who provide data or quantitative support services to Energy Affiliates and/or the Transmission Function. Generally speaking the only way to ensure that employees have been properly classified is to review the job responsibilities of each. This should not be a generic or disassociated review, but one that actively involves the employee. The employee may well have preconceived notions about what is relevant under the rules, and often those notions will be incorrect or incomplete, so it is important for the investigator to control the interview process, listen carefully to what is said by the employee, and respond dynamically with follow-up questions, as warranted. Classification of business units and companies likewise involves some situations that are more difficult than others. While many companies were able to adapt readily enough to the broader scope of the Energy Affiliate definition under Order No. 2004 and its progeny, when it came to classification of affiliates of the Transmission Provider, application of the broader definition to business units within the company at times has proven more difficult. Utilities are often organized on the basis of reporting relationships that may or may not have formal business unit designations. For example, a business unit as defined by corporate organizational charts might have 100 employees, but of these, 20, all reporting to a single person, might be involved in Energy Affiliate activities. It is not clear in such circumstances where to draw the line for purposes of defining the Energy Affiliate. Rather than consider all
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1 0 0e m p l o y e e s t ob e p o s s i b l y t a i n t e d a s e m p l o y e e s o f a nE n e r g yA f f i l i a t eb u s i n e s s u n i t , some companies have addressed such issues by expressly creating new business units that are narrowly drawn to include only the employees engaged in Energy Affiliate activities. Others m a yc h o o s e t oi n t e r p r e t t h e t e r m f u n c t i o n a l u n i t t h a t i s i n c l u d e di nt h e r u l e s d e f i n i t i o no f 62 a n a f f i l i a t e to mean a group of employees that functions together but that may be smaller than a formally designated business unit. Thus, when evaluating a grouping of employees w i t h i n a T r a n s m i s s i o n P r o v i d e r , t h e t h r e s h o l d q u e s t i o n f o r e v a l u a t i o n i s w h a t i s t h e b u s i n e s s unit?O n l y w h e n t h a t q u e s t i o n h a s b e e n c l e a r l y answered can the unit be classified. Ongoing Compliance. Ongoing programs for remaining in compliance with the independent functioning requirement of the Standards of Conduct need to be keyed to detect and report the types of occurrence that may require a fresh look at the classification of one or more employees, business units, or affiliates. Generally, the types of occurrences that a compliance program should monitor for are those that involve changing the job responsibilities or goals of an employee, business unit, or company. Some changes such as those that accompany an employee transfer are more obvious than others. However, certain other changes in responsibilities will not arise from a formal decision-making process, and will simply occur in the natural course as new circumstances arise, and employees adapt. It is difficult, if not impossible, to monitor for such changes, which is why a good training program is vital a well-trained employee should recognize that the changed circumstances require new evaluation, and contact the compliance officer. The same is true o f t h ee m p l o y e e sm a n a g e r .P e r i o d i cr e v i e wo f j o bd e s c r i p t i o n s c a nh e l pt op r e v e n t a n y short-term classification error from becoming a long-term liability. What can be monitored are the types of changes that are more formal in nature, such as an employee transfer, or a corporate reorganization. Prominent examples include: Hiring of a new employee; Promotion of an employee; Departure of an employee;63 Re-assignment or transfer of an employee; Creation of a new position; Creation or dissolution of a business unit; Restructuring of one or more business units; Changes in reporting structures;
62 63
18 C.F.R. 358.3(b)(1).
Wh e na ne m p l o y e el e a v e s t h e c o m p a n yt h a t e m p l o y e e s r e s p o n s i b i l i t i e s a r e n o t a l w a y s transferred completely to a replacement employee, but may be allocated in part among existing employees. Indeed, sometimes no replacement is hired at all.
STANDARDS OF CONDUCT FOR TRANSMISSION PROVIDERS Creation or dissolution of a company; and
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Changes in business objectives identified in individual, business unit or company mission statements or in performance evaluation criteria. Because companies typically already have in place reporting structures associated with human resources and/or the corporate secretary that are designed to detect certain business changes, such monitoring will not be wholly a new experience for most companies. However, many such programs are designed to record changes after they occur. A Standards of Conduct compliance program needs to evaluate a change before it occurs in order to ensure that the change will be consistent with the requirements of the rules an after-the-fact adjustment may still leave the company with penalty exposure. For that reason, it is our recommendation that companies consider setting up a process to require reporting of such p o t e n t i a l t r i g g e r e v e n t s before they occur, and further to prohibit such events from being consummated until associated Standards of Conduct review is completed, and any resulting recommendations have been considered. The above list can serve as a starting point for the types of events to monitor for, but can and should be changed from time to time as experience dictates. Addressing Ambiguities. It is likely that many companies, following implementation of a compliance program, will still face ambiguities in interpretation of the rules. It is often the case that an ambiguity will leave a company with compliance choices ranging from c o n s e r v a t i v e -but-bad-for-b u s i n e s s t o more-aggressive-but-better-for-b u s i n e s s . B e c a u s e of the severity of penalties, companies are usually inclined to be conservative when it is not overly onerous to do so. Sometimes, however, business necessity will drive a company to be more aggressive. In such cases it is sometimes possible, with tinkering, to strike a balance between the business objective at hand and an approach that minimizes the potential of being found to have violated the rules. Usually this is done by deciding, in effect, to look behind the ambiguous rule itself to the overall purpose of these rules, i.e., protecting competition, and making a common-sense determination whether the arrangement could have an anticompetitive effect, and if so, by tailoring the arrangement to eliminate such potential. There is, of course, risk inherent in such an approach, as there is with anything besides the most conservative interpretation of an ambiguous rule. In our view, the risks inherent in unilaterally making and adopting interpretations of ambiguities in FERC rules grew substantially when FERC issued its Enforcement Policy Statement in October 2005. The tenor of the new policy is that FERC wants utilities to adopt a more cooperative compliance relationship with the agency. Thus, one option when faced with an ambiguity is to seek guidance from FERC. This could be formal guidance, in the form of a request for clarification or waiver. Such a formal request has the benefit of providing a written record of the guidance given, but can be time and resource consuming.
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Another option is to seek informal guidance from FERC staff, in one of two forms. First, informal staff guidance historically has been obtained verbally by calling a knowledgeable member of FERC's staff. Such guidance can be delivered relatively quickly, but is often seen as being overly conservative in nature. Also, the defensive or protective value of such guidance in the face of an audit several years later is uncertain. Moreover, while informal staff guidance is not binding on FERC, it will be effectively binding on the company. If the company ultimately rejects the informal staff guidance and takes contrary action, and i f F E R Cl a t e r c o n c l u d e s t h a t t h ea c t i o nv i o l a t e dt h eS t a n d a r d s , t h ec o m p a n y s i g n o r i n g o f t h es t a f f a d v i c ew i l l a l m o s t c e r t a i n l yb eh e l da g a i n s t t h ec o mpany in any determination of appropriate penalties or other remedial action. The same FERC enforcement personnel who answer informal inquiries are also charged with initiating investigations. Thus, there is no safe harbor for information disclosed voluntarily while seeking informal guidance. Second, FERC recently adopted a policy under which its staff will respond to written requests for guidance through issuance of no-actionletters similar in form and effect to those issued by the staff of the Securities and Exchange Commission. 64 Because such letters are issued by Staff they are not legally binding on the Commission, but the program has been designed so that all staff members who would be asked to advise the Commission whether to launch an enforcement action will be consulted on the no-action letter before it is issued. Thus, while there are no guarantees, it seems unlikely that a company would be subjected to significant penalties for acting in conformance with a no-action letter. II. INFORMATION SHARING RESTRICTIONS
The information sharing restrictions are the second wing of the Standards of Conduct, and complement the independent functioning requirements discussed in Part I of this chapter. The information sharing restrictions typically are the principal focus of any FERC audit and fall into two overlapping categories: restrictions on information access, and restrictions on information disclosure. Both are discussed together here. A. BASIC REQUIREMENTS T h eb a s i c a c c e s s p r o h i b i t i o ni st h a t a Transmission Provider cannot allow any e m p l o y e eo fa n yE n e r g yA f f i l i a t e( o t h e rt h a na ne m p l o y e et h a tq u a l i f i e sa sa s h a r e d employee as discussed in Part I above) to obtain access to transmission or customer information, except on the OASIS.65 The basic disclosure prohibition is that the
Informal Staff Advice on Regulatory Requirements, Interpretive Order Regarding NoAction Letter Process, 113 FERC 61,174 (2005). 18 C.F.R. 358.5(a). Each electric Transmission Provider is required to maintain, either i n d i v i d u a l l yo r i nc o l l a b o r a t i o nw i t ho t h e r t r a n s m i s s i o np r o v i d e r s , aw e b s i t ek n o w na st h e O p e n A c c e s s S a m e T i m e I n f o r m a t i o n S y s t e m , o r O A S I S .S i m i l a r w e b s i t e s f or gas transmission providers a r e r e f e r r e d t o i n s t e a d s i m p l y a s I n t e r n e t We b s i t e s . We u s e t h e s i n g l e t e r mO A S I Sh e r e .T h e b a s i c purpose of the OASIS is to provide an electronic interface for, among other things, determining the status and availability o f t h e T r a n s m i s s i o np r o v i d e r s t r a n s m i s s i o n , a n df o r p u r c h a s i n gt r a n s m i s s i o n s e r v i c e .T h e c r e a t i o no f t h e O A S I Ss y s t e mw a s a c e n t e r p i e c e o f F E R C s s y s t e mf o r p r o v i d i n gn o n discriminatory access to transmission.
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Transmission Provider cannot disclose to any employee of any Energy Affiliate (other than a 66 s h a r e d e m p l o y e e ) a n y t r a n s m i s s i o n o r c u s t o m e r i n f o r m a t i o n , e x c e p t o n t h e O A S I S . The access and disclosure prohibitions are two sides of a coin, both aimed at the same goal of keeping transmission and customer information from Energy Affiliate employees one is a restriction against passively standing aside and allowing discriminatory access, the other is a prohibition on active discriminatory disclosure. There is no comprehensive definition of transmission information. Conceptually, transmission information is any information about the transmission system that a market participant could use to commercial advantage, in particular information about transmission operations. Further and a point that is sometimes overlooked it is not limited to i n f o r m a t i o na b o u t t h et r a n s m i s s i o np r o v i d e r sown system. In the course of coordinating operations with each other, transmission providers acquire information about other transmission systems. Such information is also transmission information subject to these restrictions.67 Transmission informationsubject to the information sharing prohibition includes (but is not limited to) the following types of information:68 Transmission flows Transmission equipment states Transmission maps, one-line drawings, or similar representations Scheduled transmission outages A v a i l a b l e T r a n s m i s s i o n C a p a c i t y ( A T C ) Transmission price and rate design Curtailment Ancillary Services Storage Balancing Transmission operating procedures Transmission marketing studies and costs
66 67 68
18 C.F.R. 358.5(b). 18 C.F.R. 358.5(b)(1). See generally 18 C.F.R. 358.5(a)(2), 358.5(b)(1).
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Identification of potential generation sites based in whole or in part on transmission data Planned or potential transmission system capital projects (expansions, upgrades, retirements, replacements, etc.) Any information about or from third party transmission customers (including potential customers), or developed in the course of responding to requests for transmission or ancillary service, except to the limited extent this information is required to be posted on OASIS.
B. THE N O-CONDUIT RULE Wh i l e t h e t h r u s t o f F E R C s r u l e s i s t op r o h i b i t d i r e c t d i s c l o s u r e o f t r a n s m i s s i o na n d customer information from Transmission Function employees to Energy Affiliate employees, FERC is equally concerned that the prohibition not be circumvented by passing information to the Energy Affiliate through employees who are not themselves part of the Transmission Function.T h u s , F E R Ch a s a d o p t e dt h e n o -c o n d u i t r u l e , w h i c hs i m p l yp r o v i d e s t h a t a n y non-Transmission Function employee of the Transmission Provider (or its affiliates) that receives transmission or customer information from the Transmission Provider is prohibited from providing that information to any employee of an Energy Affiliate (other than a shared e m p l o y e e ) .I no t h e r w o r d s , l a u n d e r i n g o r s l e e v i n g o f t r a n s m i s s i o ni n f o r m a t i o nt h r o u g h 69 non-Transmission Function employees is not allowed. The Wall. In the computer-based Standards of Conduct training we developed for the Edison Electric Institute, we stressed the concept of an information sh a r i n g w a l l . T h a t w a l l should be drawn tightly around Energy Affiliates, such that no transmission or customer information passes through the wall, with limited exceptions discussed below. 70 C. EXCEPTIONS AND REFINEMENTS There are several exceptions and refinements to the information sharing prohibitions, as follows:
S i m i l a r l y , F E R Ch e l du n d e r O r d e r N o . 8 8 9t h a t i t i si m p r o p e r t o t i po f f a nE n e r g y Affiliate employee that transmission or customer information has been posted on OASIS. American Elec. Power Serv. Corp., 81 FERC 61,332, at 62,516 (1997) ( utilities cannot comply with the requirements by providing information to wholesale merchant employees by telephone at the same time that all other customers are informed by posting on OASIS. Nor can transmission employees selectively inform wholesale merchant employees that transmission information will be posted on the OASIS at a specific time. ) .
69
Chapter 11 explains the difference in placement between the Standards of Conduct and Code of Conduct walls, and includes figures illustrating the difference.
70
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Shared Employees.71 The most important exception applies to shared employees, who may receive transmission and customer information for limited purposes, subject to the No-Conduit Rule discussed above.72 Information Directly from External Source. Energy Affiliates are not prohibited by the Standards of Conduct from obtaining transmission or customer information directly from a non-affiliated source.73 Conversely, Energy Affiliates are prohibited from receiving information about a non-affiliated transmission system or customer from the Transmission Provider affiliate of the Energy Affiliate.74 It is less clear whether the information sharing restrictions apply to third party transmission or customer information obtained first by a shared employee. Arguably, a shared employee may provide such information to an Energy Affiliate, but there is no clear precedent on point. One-Way Restriction. The restriction on information flows is, in some respects, a one-way restriction. Certainly the rules do not prohibit Transmission Function personnel from receiving transmission or customer information. Nor do they directly prohibit any particular communication from an Energy Affiliate to a Transmission Function employee. However, such communications nonetheless can be risky, in two fashions. First, FERC is suspicious of any communications between the Transmission Function and Energy Affiliates. O n eo fF E R C se a r l i e s tc a s e su n d e rt h eS t a n d a r d so fC o n d u c ti n v o l ved (among other violations) a gas pipeline employee who attended daily meetings of the marketing affiliate, but was instructed not to speakand did not actively participate.75 FERC found that the pipeline employee might have been using information from the meetings to influence pipeline operations to favor the marketing affiliate, and so FERC found attendance at the meetings to violate the independent functioning requirement discussed above. 76 Thus,
See Part I of this chapter for a discussion of the classification of employees, including shared employees. See Order No. 2004, III FERC Stats. & Regs. 31,155 at PP 145-50 & n.70; Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 197. Note, however, that a Transmission Provider conceivably could be found in violation of the basic non-discrimination requirements of section 205 of the Federal Power Act for provision of information on a discriminatory basis to a non-affiliate. Cf. Dominion Res., Inc., 108 FERC 61,110 (2004) ( a p p r o v i n gc o n s e n t a g r e e m e n t w i t hN o r t h e r nI l l i n o i s G a s C o m p a n y( N i c o r ) u n d e r w h i c h Nicor admitted that by providing non-public market information on a regular basis to a non-affiliated customer it gave that customer an undue preference and thereby violated FERC gas regulations requiring non-discriminatory open access). T h i sm a ys e e mc o n f u s i n gu n t i l o n ec o n s i d e r s F E R C s p u r p o s e , w h i c hi s t op r e v e n t a n Energy A f f i l i a t ef r o mo b t a i n i n gac o m p e t i t i v ea d v a n t a g et h r o u g hi n f o r m a t i o na c c e s s .I nF E R C s view, an affiliated Transmission Provider has an incentive to give discriminatory access absent controls, while a non-affiliated Transmission Provider has no incentive.
74 73 72 71
Amoco Prod. Co. v. Natural Gas Pipeline Co. of Am., 82 FERC 61,038, at 61,156-57 ( 1 9 9 8 ) ( Amoco ) . Id. at 61,157-58 (discussing requirement of elimination of daily meetings between employees engaged in wholesale merchant functions and employees engaged in transmission functions).
76
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regular meetings or institutionalized information exchanges of any sort are not permitted.77 Second, FERC Enforcement Staff have, over the past year or two, developed an uncodified requirement that Transmission Providers, in effect, prove the negative whenever there are meetings or communications between Transmission Function and Energy Affiliate employees. That is, they must show that no prohibited communications occurred, preferably by keeping meeting minutes.78 At a recent FERC technical conference in Chicago, FERC Enforcement Staff appeared to agree that a company may prove the lack of prohibited communications if it makes it a practice to have present at such meetings compliance personnel trained to make sure that prohibited communications do not occur, without maintaining meeting minutes. Nevertheless, given the sensitivity of business meetings between Transmission Function and Energy Affiliate employees, the existence of agendas and minutes seems the best defense in establishing the absence of improper communications. Customer Consent. A non-affiliated transmission customer may voluntarily consent, in writing, to allow the Transmission Provider to share the non-a f f i l i a t e dc u s t o m e r s 79 information with a marketing or Energy Affiliate. Own Transaction. A Transmission Provider may provide its Energy Affiliate with i n f o r m a t i o nt h a t r e l a t e ss o l e l yt ot h eE n e r g yA f f i l i a t e ss p e c i f i cr e q u e s t f o r t r a n s m i s s i o n service, so long as the response is provided in a fashion comparable to that in which the Transmission Provider responds to such requests from non-affiliates.80 Emergency Circumstances. Compliance with the Standards of Conduct information sharing and independent functioning requirements can be suspended in emergency circumstances affecting system reliability. 81 However, circumstances that would justify such a suspension are rare for example, severe weather conditions resulting in significant forced outages. Any such suspension or deviation from compliance must be reported within 24 hours.82 Crucial Operating Information. A T r a n s m i s s i o nP r o v i d e r m a ys h a r e information necessary to maintain the operations of the transmission system w i t hE n e r g yA f f i l i a t e s f o r
77 78
See also Baltimore Gas & Elec. Co., 89 FERC 61,013 at 61,054 (1999).
Note, however, that FERC removed from its draft rules a provision that would have required maintaining such records for a particular type of authorized meeting, regarding an Energy A f f i l i a t e s r e q u e s t f o r i n t e r c o n n e c t i o n . O r d e r N o . 2 0 0 4 -B, III FERC Stats. & Regs. 31,166 at P 121.
79 80
18 C.F.R. 358.5(b)(4).
Id. 358.5(b)(5); Order No. 2004, III FERC Stats. & Regs. 31,155 at PP 158-161; Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 207. 18 C.F.R. 358.4(a)(2). In rare circumstances FERC will also waive the 24 hour posting requirement. See Notice Granting Extension of Time to Comply with Posting and Other Requirements, Docket Nos. EY05-14-000, RM01-10-000, PL05-1 2( A u g . 3 1 , 2 0 0 5 )( H u r r i c a n e K a t r i n aN o t i c e ) ;N o t i c eG r a n t i n gE x t e n s i o no fT i m et oC o m p l yw i t hP o s t i n ga n dO t h e r Requirements, Docket Nos. EY05-20-000, RM01-10-000, PL05-12 (Sept. 2 3 , 2 0 0 5 ) ( H u r r i c a n e R i t a N o t i c e ) .
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18 C.F.R. 358.4(a)(2).
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the purpose of maintaining the reliability of the transmission system.83 The exception applies to information necessary to operate and maintain the transmission system on a day-to-day basis, but not transmission or marketing information that would give an Energy Affiliate an undue preference. This information may be provided only to Energy Affiliate employees engaged in the physical operations of the Energy Affiliate who need it to help maintain transmission system reliability. These operational employees may not act as a conduit by providing the information to other Energy Affiliate employees.84 Generation Dispatch. A Transmission Provider may share generation information necessary to perform generation dispatch with its Energy Affiliate. This can be information s p e c i f i ct og e n e r a t i o no w n e do rc o n t r o l l e db yt h eE n e r g yA f f i l i a t e ,o r a g g r e g a t e information that does not include specific information about individual third party transmission transactions or potential transmission arrangements.85
83
Id. 358.5(b)(8); Order No. 2004-A, III FERC Stats. & Regs. 31,161 at PP 189-206. T h eo r i g i n a l f o r m u l a t i o nf o r t h i s e x c e p t i o nw a s c r u c i a l o p e r a t i n gi n f o r m a t i o n . See id. at P 203. FERC revised the regulatory text to clarify that crucial operating information is that information n e c e s s a r y t o o p e r a t e a n d m a i n t a i n t h e t r a n s m i s s i o n s y s tem on a day-to-day basis. O r d e r N o . 2 0 0 4 B, III FERC Stats. & Regs. 31,166 at P 112. It should be noted that FERC has only discussed this exception in the context of communications between natural gas pipelines and their Energy Affiliates. See Order No. 2004-A, III FERC Stats. & Regs. 31,161 at PP 198-206; Order No. 2004-B, III FERC Stats. & Regs. 31,166 at PP 112-116. Thus, the scope of the exception in the electric transmission context is not well-defined. F u r t h e r , F E R Ch a s c a u t i o n e dt h a t t h i s e x c e p t i o n i s n o t t o b e a m e c h a n i s mt o c i r c u m v e n t t h e r u l e s . Order No. 2004, III FERC Stats. & Regs. 31,155 at P 153. 18 C.F.R. 358.5(b)(6); Order No. 2004, III FERC Stats. & Regs. 31,155 at P 154. This exception was also in place under the prior Order No. 889 rules. See, e.g., Allegheny Power Serv. Corp., 84 FERC 61,131, at 61,715-16 (1998) (upholding exception where information was not transmission-related). Thus, FERC considered in that context what types of information might fall w i t h i nt h e e x c e p t i o n .I na c a s e i n v o l v i n gI n d i a n a p o l i s P o w e r &L i g h t C o . ( I P L ) , F E R Ca p p r o v e d access to the following types of information: aggregate of scheduled interchange; aggregate of actual i n t e r c h a n g e ; i n t e r c h a n g e r a m pr a t e ; a r e ac o n t r o l e r r o r ( A C E ) f o r r e g u l a t e di n t e g r a t e dA C E ; A C E control boundaries; NERC Control Performance compliance factor; net generation and capacity operated by IPL; IPL load spinning reserve requirements; actual system operating reserve requirements; actual and scheduled system frequency; frequency alarm and automatic generation c o n t r o l ( A G C ) l i m i t s ; w e a t h e r i n f o r m a t i o n ; g e n e r a t o r u n i t c o n d i t i o n a l a r m s ; g e n e r a t o r AGC control alarm; failed telemetering indication; AGC status (on/off); economic dispatch mode; AGC control mode; system lambda; frequency bias factor; time error; manual and automatic inadvertent energy payback; load forecast; gross MW; auxiliary MW; net MW; high/low limits for AGC; S02 allowance costs; unit AGC control mode and sub-mode; AGC impulse indicator; AGC base point; raise and lower ramp rates; high and low regulation; gross MVAR and bus voltage; heat rate and incremental heat rate curves; unit fuel costs; generator breakers and disconnect status; NERC Control Performance calculations by hour for the current day and seven days prior; net system hourly generation costs; total operating costs (total fuel, operating and maintenance costs of each generating unit); local or remote control status (an indicator for controlling generation). In approving this list, F E R Ca c c e p t e d I P L s s t a t e m e n t t h a t t h i s d a t a w o u l dn o t a l l o wt h e d e r i v a t i o no f t r a n s m i s s i o n s y s t e m information, nor would it provide direct or indirect access to information regarding third-party transmission customers. IPL further stated that wholesale merchant function employees would not
85 84
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Other Types of Aggregated Information. As set forth in FERC s regulations, the e x c e p t i o n f o r a g g r e g a t e d d a t a i s l i m i t e d t o i n f o r m a t i o n n e c e s s a r y f o r g e n e r a t i o n dispatch.86 Until recently it was commonly believed in the industry that, working by analogy to the generation dispatch exception, other types of aggregated data could be shared, so long as underlying transmission or customer information was not disclosed and could not be derived from the aggregated data. However, such beliefs were challenged in the summer of 2004 by the Dominion order, which approved a settlement of an investigation that alleged, among other things, that an improper disclosure had occurred where Energy Affiliate employees had been provided with gas inventory forecasts that were based upon 24 sources of data, of which only one source was non-public, prohibited transmission information. 87 D. COMPLYING WITH THE INFORMATION SHARING RESTRICTIONS We l i v ei nat i m ep e r i o dc a l l e dt h e I n f o r m a t i o nA g e i nl a r g ep a r t b e c a u s eo f t h e proliferation of means and capabilities for delivery of information. While no doubt useful to society, this proliferation is the enemy of the compliance team. In order to best ensure compliance with the information sharing rules, a company first needs to understand, in a way it probably never has before, the many channels of communication that have sprung up internally, some formal, some informal, some traditional, some based on new technologies. The following are common issues that arise in determining whether a company is in compliance with the information access and disclosure rules:88 D oE n e r g yA f f i l i a t ee m p l o y e e sh a v e l e g a c y t r a n s m i s s i o ni n f o r m a t i o nt h e y obtained in another role, or even before FERC adopted the Standards of Conduct? Are Transmission Function workplaces secure? Are sufficient precautions being taken to prevent access to transmission information in workspaces of shared employees? Does the company have a process to ensure that security access restrictions are updated when employees move or workspaces are altered?
have access to information regarding transmission flows, transmission equipment states, results of security applications, state estimators, load flows, scheduled transmission outages, transmission operating procedures, transmission historical data, transmission marketing studies and costs, transmission schedules, available transmission capability calculations, and transmission loading alarms. Indianapolis Power & Light Co., 90 FERC 61,174, at 61,575-76, order on compliance filing, 92 FERC 61,002, at 61,003 (2000).
86 87 88
18 C.F.R. 358.5(b)(6). Dominion Res., Inc., 108 FERC 61,110 (2004).
In the event of a prohibited information disclosure, an additional specific compliance requirement is created, as discussed separately in the next subsection.
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Wh a t r e p o r t so r o t h e r h a r d -c o p y d o c u m e n t sa r eg e n e r a t e dt h a t m a yi n c l u d e transmission or customer information? Who receives them? Is there a process for maintaining and updating distribution lists for such documents? What electronic databases, monitoring and modeling programs, and other computer programs contain or utilize transmission or customer information? What firewalls or other protections are in place to prevent electronic access to transmission information by Energy Affiliates?89 What is the process for maintaining protections when software is updated or replaced, when hardware configurations are changed, or when maintenance is performed? What happens with respect to such protections if a new employee is hired, or an existing employee is transferred or has changed job responsibilities? What group email distribution lists exist on the company computers? What rules govern such lists? Is there a periodic review? Are there regular meetings or telephone calls between Transmission Function and Energy Affiliate personnel? What for? Are compliance personnel present to guard against improper communications? Are meeting records kept? Does the company have other regular means of communicating transmission information, such as pagers or text messaging? What measures are taken to ensure that Energy Affiliate employees do not receive such communications? What is the process for communications with an Energy Affiliate regarding its transmission requests, and is it comparable to the process for non-affiliates? How is the company addressing Energy Affiliate requests for customer information? Does the company utilize the crucial operating information exception? What is the process? Who receives the information, and why? Do they observe the noconduit rule?
As discussed above, while the Standards of Conduct do not expressly prohibit transmission function acce s st oE n e r g yA f f i l i a t ei n f o r m a t i o n ,s u c ha c c e s sm a ya p p e a ri nF E R C se y e st o contravene the requirement of independent functioning in some circumstances. See, e.g., Amoco, 82 FERC 61,038 at 61,157 (holding that the presence of an operating employee at meetings of m a r k e t i n g a f f i l i a t e p l a c e d h i mi n a p o s i t i o n t o t a i l o r [ t h e c o m p a n y s ] transportation decisions to [the] needs of [its] m a r k e t i n g a f f i l i a t e ) .F o r t h a t r e a s o n , i t m a y b e p r u d e n t f o r a c o m p a n y t oe v a l u a t e t h e degree to which its Transmission Function may have access to non-public Energy Affiliate databases.
89
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Is the company providing generation dispatch information to its Energy Affiliates? What information?
As with the independent functioning requirement, compliance with the information s h a r i n gr e s t r i c t i o n sc a nb ed i v i d e di n t ot w op a r t s : ( 1 ) a s n a p s h o t e v a l u a t i o no f c u r r e n t compliance, which will be primarily substantive in nature, and (2) a forward-looking evaluation of programs and systems in place to ensure continued compliance as relevant facts inevitably change. Current Compliance. There are six areas that are central to an evaluation of current compliance with the information sharing restrictions: (1) physical access to areas where transmission information may be present; (2) receipt of documents that may contain transmission information; (3) electronic access to databases or programs that may contain t r a n s m i s s i o ni n f o r m a t i o n ; ( 4 ) e l e c t r o n i cr e c e i p t o f t r a n s m i s s i o ni n f o r m a t i o n ; ( 5 ) l e g a c y information currently in possession of Energy Affiliates, and (6) meetings or calls particularly regularly scheduled meetings or calls that provide a potential basis for verbal information disclosures. Physical access to areas where transmission information may be present. Under the old (Order No. 889) rules, a Transmission Provider had a specific obligation to set up physical restrictions on access to areas, such as the control center, where transmission information would be available. A common measure was to establish security locks that required a card key for access. Another was to require locking of file cabinets. While these measures were required for areas where the Transmission Function operated, they apparently were not required for shared employee workspaces (although FERC auditors were likely to inquire as to what transmission information a visitor to shared employee workspace might have effective access). The new rules more generally require the posting of procedures for compliance, including compliance with the information access restrictions. But affirmative access restrictions still are expected. We believe that good physical security measures are an important and relatively easy safeguard to implement for any physical sources of transmission information. Some companies may wish to apply a rule of reason a source of transmission information housed in the same building as Energy Affiliates warrants tight safeguarding, whereas a building that is not visited by Energy Affiliate employees may not need arrangements as extensive. To assess compliance, we recommend (1) creation of a list of workspaces of Transmission Function and shared employees, and (2) assessment of the sufficiency of current safeguards based upon the likelihood of access by Energy Affiliate employees. Receipt of documents that may contain transmission information. As discussed a b o v e , t h e i n f o r m a t i o n s h a r i n g r e s t r i c t i o n s c o n t a i n b o t h a c c e s s a n d d i s c l o s u r e prohibitions, so it is not enough to make sure that access is blocked. An assessment of compliance also should look at disclosure issues, because a violation is just as likely to be found if transmission information compiled in a locked room is put in a report and distributed to an Energy Affiliate employee. It is not possible to anticipate every possible form of document disclosure, but it is
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possible to identify and evaluate potential routine forms of disclosure. In particular, Transmission Function and shared employees should be asked to provide distribution lists for any documents they distribute on a regular basis. For example, while the final version of an annual report is public and can be distributed, drafts containing non-public transmission information should not go to Energy Affiliate employees. Electronic access to databases or programs that may contain transmission information. Hardware and software configurations of computer systems are unique and may vary widely from company to company. Moreover, evaluation can be complicated by the reality that compliance personnel and IT personnel 90 o f t e nh a v e v e r yl i t t l e r e a l u n d e r s t a n d i n go f e a c h o t h e r s a r e a s o f s p e c i a l i z a t i o n . However, in general terms, what the compliance team needs from the IT team is a map or matrix showing all databases or programs that may contain transmission information. An example would be the Energy Management System or other system for monitoring the transmission system in real time. Another would be a modeling program that includes a representation of all or a portion of the transmission system. It is important to note that the IT team may not know of every such database or program on the system that will depend on the extent 91 a n de f f e c t i v e n e s s o f t h e c o m p a n y s p o l i c i e s a n dc o n t r o l s o nu s e o f t h e s y s t e m . In such cases the IT team will need to conduct a survey of the system. Once a list of databases and programs has been compiled, the IT team should complete the map or matrix by identifying all persons who have access to each such database or program. Access should be assumed unless there is a physical or electronic barrier to access, such as a firewall or password protection. The compliance team can then determine whether any person with access to such a database is an Energy Affiliate employee. The compliance team and the IT team should work together to determine the best means of removing access by any such employee. Electronic receipt of transmission information. The issues associated with electronic receipt of transmission information are similar to those with respect to physical receipt. It may not be practical to guard against a stray email other than t h r o u g hag o o dt r a i n i n gp r o g r a m .H o w e v e r , e m a i l g r o u p d i s t r i b u t i o nl i s t s a r e becoming increasingly pervasive, and our experience is that they are rarely updated or corrected except to add more people. We recommend that the IT department compile a list of the saved groups of each Transmission Function and shared employee, and provide those to the compliance team for a determination whether the group members include Energy Affiliate employees. Every person authorized to use a group that includes Energy Affiliate employees should be
There are, of course, exceptions. Representatives of the Williams Companies have spoken at Edison Electric Institute compliance officer meetings about the extensive integration between their compliance and IT teams a model others may find it worthwhile to consider. Additionally, data or programs may be stored from time-to-t i m eo na s t a n d -a l o n e computer that is not accessible remotely. In such cases, it may be sufficient to have restrictions on physical access to the place where the computer is stored.
91 90
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK questioned as to the use to which the group is put, and reminded to be careful to consider the no-conduit rule in sending and responding to group emails. To the extent that the group is or may be used for the distribution of transmission information, Energy Affiliate employees should be removed. Additionally, the compliance team should work with the IT team and each of the business units to determine whether other means of electronic distribution of transmission information are employed, and if so should evaluate whether that information is distributed to Energy Affiliate employees. For example, some companies use pagers to relay real-time transmission outage information. This would not be appropriate for transmittal to Energy Affiliate employees. L e g a c y i n f o r m a t i o nc u r r e n t l yi np o s s e s s i o no fE n e r g yA f f i l i a t e s . In our experience there is a category of transmission information that Energy Affiliate employees may possess that does not fit neatly into any of the above categories because the Energy Affiliate no longer has access to or receives such information. T y p i c a l l ys u c hi n f o r m a t i o nh a s b e e ni nt h ee m p l o y e e s p o s s e s s i o ns i n c eat i m e when the employee was not prohibited from obtaining it either since the time t h a t( 1 ) t h e S t a n d a r d s o f C o n d u c t w e r e f i r s t i m p l e m e n t e d , o r ( 2 ) t h e e m p l o y e e s designation was changed to Energy Affiliate status. Policing this type of issue can be time-consuming. A thorough check would require examination of physical and electronic files of any Energy Affiliate employee who had previously had a transmission or shared role at the same company. A less time intensive approach would be to ask such employees a series of questions designed to jog their memories. Such questions cannot be conclusory, because sometimes the employee will not realize that information in their possession could be problematic. For example, an employee may have a collection of old maps or one-line drawings that he or she may not consider to be transmission information because they are not real-time in nature and have no apparent competitive value. Meetings or calls that provide a potential basis for verbal information disclosures. FERC Staff are extremely suspicious of any meetings that involve both Transmission Function and Energy Affiliate employees. They see few reasons for such meetings that are consistent with the Standards of Conduct, and case law under the old rules consistently prohibited (or punished) regular meetings because of the potential for creating an institutional track for off-OASIS communications.92 The compliance team may wish to interview Transmission Function and Energy Affiliate employees to see whether they interact at meetings or on phone calls, and if so determine what the purpose is. If transmission information is disclosed in such meetings, it should be pursuant to an established exception, such as that for crucial operating information, or to determine the status of th eE n e r g yA f f i l i a t e st r a n s m i s s i o nr e q u e s t .A n yr e g u l a r l ys c h e d u l e d meetings or calls should be subject to especially rigorous evaluation, and in all likelihood should be discontinued. Finally, as discussed above, compliance
92
See Amoco, 82 FERC 61,038 (1998); Baltimore Gas & Elec. Co., 89 FERC 61,013
(1999).
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personnel should attend such meetings, and FERC Staff believes that companies should maintain meeting minutes of any such meetings to help establish that no improper disclosures occurred. Ongoing Compliance. Once an initial compliance snapshot has been taken and any corrective measures have been addressed, ongoing compliance with the information sharing restrictions will depend in large part on having a program designed to detect changes that will affect the six compliance areas discussed above, i.e., (1) physical access to areas where transmission information may be present; (2) receipt of documents that may contain transmission information; (3) electronic access to databases or programs that may contain transmission information; (4) electronic receipt of transmission information; (5 ) l e g a c y information currently in possession of Energy Affiliates; and (6) meetings or calls that provide a potential basis for verbal information disclosures. For each of these it will be necessary to determine the types of events that can trigger a need to review information access or disclosure safeguards. Because issues arise most commonly when an employee or business unit is reclassified, evaluation of information access and disclosure measures should be automatic whenever such a reclassification occurs.93 For example, an employee's reclassification from Transmission Function to Energy Affiliate could create issues in all six areas discussed above, and should be addressed by ensuring that: appropriate physical and electronic access safeguards are implemented with respect to the employee; the employee is removed from document and email distribution lists that may involve distribution of transmission information; the employee does not carry transmission information to his or her new workspace; and the employee is dropped from automatic meeting invitation lists.94 More generally, the employee should be retrained on Standards of Conduct c o m p l i a n c e , a n dt h e e m p l o y e e s f o r m e r c o -workers should be reminded of the Standards of Conduct implications resulting fro mt h e f a c t t h a t t h e e m p l o y e e h a s c r o s s e d t h e w a l l .
Put differently, the same issues that can raise a reclassification concern, as discussed above in Part I of this chapter, can raise a concern with respect to whether existing information sharing safeguards remain sufficient. Conversely, reclassification of an employee to the Transmission Function means that any existing safeguards prohibiting the employee from obtaining transmission information no longer are necessary, and may be removed, but must be replaced with safeguards to prevent the employee from disclosing the transmission information improperly. This, of course, is in addition to measures d i s c u s s e d i n P a r t I r e g a r d i n g a c o o l i n g o f f p e r i o d . See supra note 61.
94
93
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However, employee and business unit reclassifications are not the only reason that information safeguards fail. Often problems occur due to changes that render existing protections incomplete or ineffective. Prominent examples of such changes include: Changes to workspace arrangements, such as workspace reconfigurations or relocation of an employee or group; Changes to computer hardware, such as server configurations or physical firewalls; Changes to software, such as the addition of a new program or data portal; Temporary arrangements, such as a relaxation of security to permit construction or maintenance, that become permanent when security measures inadvertently are not restored; and Creation of new email or document distribution lists. Generally, companies already have in place processes for advance approval of some such changes, but in many cases such approval processes will not be centralized, but rather will be the province of individual business units, without consultation with compliance personnel. A Standards of Conduct compliance program needs to provide for evaluation of such changes before they occur. It is our recommendation that companies consider setting up a process to require reportingo f s u c hp o t e n t i a l t r i g g e r e v e n t st oc o m p l i a n c ep e r s o n n e l before they occur, and further to prohibit such events from being consummated until associated Standards of Conduct review is completed, and any resulting recommendations have been considered. The above list (together with the related list provided in the discussion of compliance with independent functioning requirements) can serve as a starting point for the types of events to monitor for, but can and should be changed from time to time as experience dictates. E. TREATMENT OF AN IMPROPER DISCLOSURE If an employee of the Transmission Provider discloses information in a manner contrary to the information disclosure rules discussed above, the Transmission Provider must immediately post such information on the OASIS or Internet website.95 FERC states that [ c ] o n t e m p o r a n e o u sp o s t i n ga n dt r a n s p a r e n c ya r eo n eo f t h em o s t e f f e c t i v ed e t e r r e n t st o 96 favoritism, undue discrimination and anti-c o m p e t i t i v e c o n d u c t . From a compliance standpoint, treatment of an improper disclosure can be one of the more difficult exercises under the Standards of Conduct. Rarely is a disclosure so easily understood that a course of action is obvious, which makes fact-finding an important part of the process. That fact-finding in turn can be complicated by employees concerned that they
95 96
18 C.F.R. 358.5(b)(3). Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 223.
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may be blamed for a disclosure, though in our experience this is not as common as one might expect. It is often the case that fact-finding will reveal that no improper disclosure occurred. Sometimes investigation shows that the information in question was not transmission information, or that it falls into one of the exceptions to the disclosure prohibition. Other times it may be that transmission information was disclosed to some people who are not in the Transmission Function, but not to an Energy Affiliate employee. In other cases it will be virtually impossible to prove that no improper disclosure occurred, even though there may be no evidence that a disclosure in fact occurred. The most common such situation is when there is a failure in an access restriction, such as a computer firewall, but no evidence that any Energy Affiliate employee actually took advantage of it. If a disclosure occurred or may have occurred the issue becomes What should be posted on OASIS? For example, the extent or duration of a disclosure may not be known, or some of the information disclosed may no longer be available. Again, such questions often arise in cases of failed firewalls or other access restrictions, where it is known that the protection was not in place, but not known what information, if any, was disclosed.97 Other cases that cause questions about what to post include instances where the material disclosed is particularly voluminous, but not available in electronic form, or where the material involves customer specific information, the disclosure of which could cause that customer competitive harm. It hardly seems reasonable to, in effect, further punish a customer by disclosing information the customer may deem to be confidential. 98 In cases where difficult questions arise, companies have choices, including the formal and informal FERC inquiries discussed in Part I, section C of this chapter. Each of those takes time, however, and has other potential drawbacks, not the least of which is that the rules impose an immediate posting obligation. In complex situations such as those described above, some companies historically chose a middle-road approach of posting a fair and full description of the circumstances of the actual or possible disclosure on their OASIS, sometimes also offering to join any interested party in an inquiry to FERC as to how to proceed. To our knowledge, FERC has not formally approved or disapproved this approach.
Interestingly, the immediate posting requirement, if read literally, applies only to a p r o h i b i t e dd i s c l o s u r e , n o t t oav i o l a t i o no ft h e i n f o r m a t i o na c c e s s p r o h i b i t i o n s .1 8C . F . R . 3 5 8 . 5 ( b ) ( 3 ) ( r e q u i r i n gi m m e d i a t ep o s t i n go f i n f o r m a t i o nd i s c l o s e d i nam a n n e r c o n t r a r yt ot h e r e q u i r e m e n t s o f 3 5 8 . 5 ( b ) ( 1 ) a n d ( 2 ) , t h e p r o h i b i t e dd i s c l o s u r e p r o v i s i o n s , w h i l e r e m a i n i n g s i l e n t a s t o 3 5 8 . 5 ( a ) ( 1 ) a n d ( 2 ) , t h e i n f o r m a t i o n a c c e s s r e s t r i c t i o n s ) .T h i s s u g g e s t s t h a t i f n od i s c l o s u r e occurs, no posting is required, but leaves open the question of proving that no disclosure occurred. Also, while no posting may be required, a company seeking to adopt the approach encouraged in FERC's Enforcement Policy Statement should still self-report the failure of information access protections. Cf. Order No. 2004-B, III FERC Stats. & Regs. 31,166 at PP 97-98 (noting that posting of discretionary log should not reveal confidential customer information or sensitive business information; rather, a Transmission Provider should post information regarding the date of its action and the type of discretion it exercised without revealing the name of the customer).
98 97
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For companies adopting the approach encouraged by FERC in its Enforcement Policy Statement, the question of whether and what to post also will be tied to the question of whether and what to self-report to FERC. III. ADMINISTRATIVE REQUIREMENTS
The third set of requirements under the Standards of Conduct are largely administrative in nature and include the following: tariff administration requirements, OASIS or Website posting requirements, and other compliance requirements. Note that there is some overlap between the three, and also that some of these requirements relate back to previously discussed requirements. A. TARIFF ADMINISTRATION The basic tariff requirement is that a Transmission Provider may not, through its tariffs or otherwise, give preference to its own marketing or sales function or to any Energy Affiliate over any other wholesale customer in matters relating to the sale or purchase of transmission service (including, but not limited to, issues of price, curtailments, scheduling, priority, ancillary services, or balancing). Non-discretionary terms. A Transmission Provider must strictly enforce all tariff provisions relating to the sale or purchase of open access transmission service, if these tariff 99 provisions do not permit the use of discretion. Discretionary Terms. I f aT r a n s m i s s i o nP r o v i d e r s t a r i f f p r o v i s i o n s r e l a t i n gt ot h e sale or purchase of open access transmission service permit the use of discretion, it must apply those provisions in a fair, impartial and non-discriminatory manner.100 The Transmission Provider must maintain a written log, available for a FERC audit, detailing the circumstances and manner in which it exercised its discretion under any terms of the tariff.101 The information contained in this log is to be posted on OASIS within 24 hours of when a Transmission Provider exercises its discretion under any terms of its tariff.102 Any offer of a discount for any transmission service made by the Transmission Provider must be posted on OASIS contemporaneous with the time that the offer is 103 contractually binding. The posting must include: the name of the customer involved in
99 100 101 102
18 C.F.R. 358.5(c)(1). Id. 358.5(c)(2). Id. 385.5(c)(4).
The posting should not reveal confidential customer information or sensitive business information. Rather, a Transmission Provider should post information regarding the date of its action and the type of discretion it exercised (e.g., a creditworthiness determination) without revealing the name of the customer. See Order No. 2004-B, III FERC Stats. & Regs. 31,166 at PP 97-98. T h e t i m e ad i s c o u n t o f f e r i s c o n t r a c t u a l l yb i n d i n gm e a n s t h e t i m e t h a t b o t hp a r t i e s a r e b o u n d . O r d e r N o . 2 0 0 4 -A, III FERC Stats. & Regs. 31,161 at P 229.
103
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the discount and whether it is an affiliate or whether an affiliate is involved in the transaction, the rate offered, the maximum rate, the time period for which the discount would apply, the quantity of power or gas upon which the discount is based, the delivery points under the transaction, and any conditions or requirements applicable to the discount.104 The posting must remain on the OASIS or Internet website for 60 days from the date of posting. Compliance. In our experience, the tariff administration requirements have received less attention than the independent functioning and information sharing requirements, but we anticipate that will change with the new penalties of up to one million dollars per violation per day. Some utilities maintain that they do not exercise discretion under their tariffs for example, that they do not offer discounts. Such a course, if maintained and if consistent with business objectives, does minimize risk of violation of these requirements. Companies may wish to consider a three-part procedure for assessing risk and addressing compliance under these tariff administration rules: 1) Assess each provision of the open access tariff and determine whether the provision allows the exercise of discretion. 2) Establish a process for prior review of exercises of discretion under such provisions to ensure that such exercises of discretion will be carried out on a nondiscriminatory basis. 3) Establish a process to meet applicable OASIS posting requirements.
B. OASIS POSTING REQUIREMENTS105 Each Transmission Provider is required by the Standards of Conduct regulations to post on OASIS the following:106
FERC recognizes that the Transmission Provider may not know, at the time the offer is contractually binding, the actual quantity to be scheduled. The Transmission Provider, however, must identify whether it is posting the volumetric information based upon the maximum daily quantity or the scheduled volume. Order No. 2004-C, III FERC Stats. & Regs. 31,172 at P 42. The posting requirements discussed in this chapter are solely those required by the Standards of Conduct. An electric utility Transmission Provider that no longer has its own OASIS, presumably because it participates in an RTO or ISO with an OASIS, should make arrangements to have the OASIS provider, e.g., t h eR T Oo rI S O , i n c l u d eal i n kt ot h eT r a n s m i s s i o nP r o v i d e r s i n f o r m a t i o n . T h e l i n ks h o u l db e d i r e c t l yt ot h e i n f o r m a t i o np o s t i n g s , s ot h e u s e r d o e s n o t h a v e t o search t h ew e b s i t ef o rt h er e l e v a n t i n f o r m a t i o n . O r d e rN o . 2 0 0 4 -A, III FERC Stats. & Regs. 31,161 at P 178. FERC Staff used a similar checklist in the first phase of their current round of compliance audits. See Federal Energy Regulatory Commission Open Public Meeting, Jan. 19, 2005, Transcript at 35-36.
106 105
104
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Its written procedures for compliance with Order No. 2 0 0 4 i n such detail as will enable customers and [FERC] to determine that the Transmission Provider is in 107 c o m p l i a n c e . Each emergency that resulted in any deviation from the Standards of Conduct, within 24 hours of its occurrence.108 Names and addresses of marketing and sales units and Energy Affiliates.109 Identification of shared facilities and their locations.110 Shared personnel and job descriptions.111 Comprehensive organization charts of the parent company.112 Organizational charts of the Transmission Provider, showing business units, job titles and descriptions, and chain of command for all positions except clerical,
1 8C . F . R . 3 5 8 . 4 ( e ) ( 3 ) .T h i sr e q u i r e m e n t i sm o r et h a naf o r m a l i t ya n d [ m ] e r e l y r e s t a t i n g t h e r e g u l a t i o n s o r i n c o r p o r a t i n g t h e mb y r e f e r e n c e i s n o t s u f f i c i e n t .Standards of Conduct for Transmission Providers, Notice of Proposed Rulemaking, FERC Stats. & Regs., Proposed Regs. 1999-2003 32,555, at 34,086 (2001). Rather, Transmission Providers must explain the measures they use to implement the Standards of Conduct. Id. The procedures should: identify and explain the measures the Transmission Provider uses to keep secure transmission information and confidential customer information, such as locked file rooms, card-key access to control center and/or password restricted databases; identify the Chief Compliance Officer, describe his or her general duties and functions, and provide contact information; identify any categories of employees shared between the Transmission Provider and its Energy Affiliates (it is not necessary to identify the names of the shared support employees); identify procedures that will be used to make sure that the names and addresses of its Energy Affiliates, organizational charts and job descriptions, merger, transfer, tariff waiver and discount information are kept up-to-date on the OASIS or Internet website, and are a r c h i v e dc o n s i s t e n t w i t hF E R C sr e g u l a t i o n s ; a n di d e n t i f yp r o c e d u r e st oe n s u r et h a t i n f o r m a t i o n , including documents and communications, are retained to demonstrate that the Transmission Provider is in compliance with the Standards of Conduct. See Standards of Conduct for Transmission Providers, Guidance on Informational Filings and Implementation Procedures for Standards of Conduct Under Order No. 2004, 106 FERC 61,017 at P 6 (2004); Order No. 2004, III FERC Stats. & Regs. 31,155 at P 136.
107
18 C.F.R. 358.4(a)(2). The transmission provider must also report such deviation to FERC in the same time frame. Id.
109 110 111
108
Id. 358.4(b)(1). Id. 358.4(b)(2).
Id. 358.4(b)(3)(i); Order No. 2004, III FERC Stats. & Regs. 31,155 at P 125; Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 164.
112
18 C.F.R. 358.4(b)(3)(i).
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maintenance and field positions. The charts must identify transmission or sales functions and their supervisors.113 Detailed information, including job descriptions and names of personnel engaged in Transmission Functions who also engaged in marketing and sales functions or who are employed by an Energy Affiliate.114 Transfers of employees between the Transmission Function and the marketing and sales unit/Energy Affiliate.115 Names and addresses of potential merger candidates within seven days of an announced merger.116 Any transmission information that was disclosed to an Energy Affiliate employee contrary to the information sharing prohibition.117 This must be posted immediately. Voluntary consent notices in which a non-affiliated customer authorizes the provider to share information with marketing/Energy Affiliates.118 Log of the circumstances and manner in which the transmission provider exercised discretion under its tariff, within twenty-four hours of the exercise of discretion.119
Id. 358.4(b)(3)(ii). To fulfill its posting obligations, the Transmission Provider must identify the business units that are share dw i t hi t s E n e r g yA f f i l i a t e s . I f a c o r p o r a t i o n u s e s a s e r v i c e company as the employment mechanism for the Transmission Provider and its [Energy Affiliates], the organizational charts should clearly specify those circumstances. Similarly, if a Transmission Provider uses both functional and structural organizational charts for its management, the organizational charts must accurately reflect its operations. Support units that are shared between a Transmission Provider and its [Energy Affiliates] must be c l e a r l y i d e n t i f i e d . O r d e r N o . 2 0 0 4 -A, III FERC Stats. & Regs. 31,161 at P 163. 1 8C . F . R . 3 5 8 . 4 ( b ) ( 3 ) ( i i i ) .T h i sr e q u i r e m e n t i sa na r t i f a c t o f F E R C sr e g u l a t i o no f natural gas pipelines under earlier Standards of Conduct rules, and as a practical matter we think it unlikely that a situation would arise in which an electric Transmission Provider would be permitted to have a single employee engaged in both Transmission Functions and Energy Affiliate activities.
114 115 116 117
113
Id. 358.4(c)(iv). Id. 358.4(b)(3)(v). Id. 358.5(b)(3). Treatment of prohibited disclosures is discussed in Part II.E of this 18 C.F.R. 358.5(b)(4). Customer consent to disclosure is discussed in Part II.C of this 18 C.F.R. 358.5(c)(4). See the discussion in Part III.B of this chapter.
chapter.
118
chapter.
119
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Discount information, which must be posted contemporaneously with the time that the offer of discount becomes contractually binding and must remain on the site for sixty days.120
Changed Facts. Inaccuracies in information required to be posted on OASIS under the Standards of Conduct must be corrected within seven business days of the change in facts that renders the existing posting inaccurate. The date of the change also must be posted.121 Compliance. In our experience, these posting requirements are another area that many companies would be well served to devote additional attention to in light of the s i g n i f i c a n t i n c r e a s ei nF E R C s p e n a l a u t h o r i t yand the Enforcement Policy Statement. In some companies the responsibility for maintaining OASIS postings is not closely tied to the compliance department. Related to this, some business units with detailed information required for certain postings for example, Human Resources usually has information on employee transfers are not always integrated into the process for maintaining up-to-date postings. Some companies appear to draw a sense of security from positive results of F E R C s r e c e n t p h a s e 1 a u d i t s o f O A S I Sp o s t i n g s .We b e l i e v e , h o wever, that such a sense o f s e c u r i t ym a y b e f a l s e i nt h a t F E R C s p h a s e 1a u d i t s w e r e a s i m p l i f i e dr e v i e wo f w h e t h e r the appropriate categories of postings are provided for on the OASIS of each Transmission Provider not a review of the substance of those postings. That substantive review of O A S I Sp o s t i n g s i s o n e s u b j e c t o f t h e p h a s e 2 a u d i t s n o wu n d e r w a y . In terms of devising or improving a compliance program for these posting requirements, a good first step would be to ensure strong ties between the individuals responsible for postings and those responsible for compliance, since many of the posting requirements derive from compliance matters that the compliance team should be monitoring. For example, many of the posting requirements pertain to employee classifications, and we provide above detailed suggestions regarding development of a compliance process with respect to employee classifications. In many cases, meeting the posting requirement will be the tail end of a well-devised and executed program addressing larger compliance issues. Companies may wish to use the above checklist as the basis for: (1) determining the extent to which each posting requirement relates to another compliance program; (2) ensuring that the need to post information on OASIS is identified; and (3) assessing (or establishing) monitoring programs to ensure that needed postings have in fact been made. For any posting requirements that are more stand-alone in nature (e.g., posting of potential merger candidates after a merger is announced), companies will require a standalone process. For some requirements the options for developing a process may be limited, and may consist largely of training of persons likely to become aware of facts requiring a posting.
120 121
18 C.F.R. 358.5(d). See the discussion in Part III.B of this chapter.
18 C.F.R. 358.4 (b)(3)(iv). Technically, this requirement applies only to information r e q u i r e d t o b e p o s t e d p u r s u a n t t o t h e i n d e p e n d e n t f u n c t i o n i n g r e g u l a t i o n .
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For all categories of postings, we believe it makes sense for companies to conduct periodic reviews. In addition to assessing accuracy of required information, such reviews may disclose stale information that is no longer required to be posted. C. OTHER COMPLIANCE REQUIREMENTS The Standards of Conduct regulations set forth the following additional compliance requirements for Transmission Providers: To distribute the written procedures for complying with the Standards of Conduct to all Transmission Provider employees and employees of the Marketing and Energy Affiliates.122
123 T or e q u i r ea l l o ft h e i ro f f i c e r s , d i r e c t o r s , a n de m p l o y e e sw i t h a c c e s s to transmission information or information concerning gas or electric purchases, sales or marketing functions to attend training and to require each employee to sign a document or certify electronically signifying that he or she has participated in the training.124 In our view, training is a relatively inexpensive compliance measure and it makes sense to err on the side of conservatism in determining who should be trained. Training should be refreshed annually.
To designate a Chief Compliance Officer who will be responsible for Standards of Conduct compliance.125 In practice the Chief Compliance Officers of many companies in turn designate a subordinate responsible for day-to-day compliance issues, subject of course to the requirement that the Chief Compliance Officer retains responsibility for compliance. To maintain books of account and records separately from those of Energy Affiliates and keep them available for inspection by FERC.126
122 123
Id. 358.4(e)(4).
I t s h o u l d b e n o t e d t h a t F E R Ch a s n o t e x p l a i n e dw h a t i t m e a n s i n t h i s c o n t e x t b y a c c e s s t o t r a n s m i s s i o ni n f o r m a t i o n . P r e s u m a b l y a T r a n s m i s s i o n P r o v i d e r w i l l h a v e e m p l o y e e s w i t h a c c e s s to transmission information (e.g., through access to company computer databases or workspaces) who will never make use of that access or who are not likely to be in a position to serve as conduits of transmission information to Energy Affiliates (e.g., custodial personnel). Id. 358.4(e)(5). A computer-generated certificate (for example, one generated at the conclusion of a computer-based training program) is acceptable as a means of certifying completion of training in lieu of a signed affidavit. Id. 358.4(e)(6). Several affiliated Transmission Providers within the same corporate family may designate the same Chief Compliance Officer who will be responsible for Standards of Conduct compliance activities. Order No. 2004-A, III FERC Stats. & Regs. 31,161 at P 188. 18 C.F.R. 358.4(d). This requirement does not apply to Energy Affiliates that are a division of a Transmission Provider. Order No. 2004-B, III FERC Stats. & Regs. 31,166 at P 134.
126 125 124
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK IV. PENALTIES AND CORRECTIVE ACTIONS
FERC has not litigated any cases under the new Standards of Conduct. Settlements and orders resulting from investigations and audits under the old rules involved substantial pen a l t i e s , n o t w i t h s t a n d i n gF E R C s l a c ko f c l e a r p e n a l a u t h o r i t yprior to passage of EPAct 2005. The chart on the following pages summarizes settlements in cases that involved alleged Standards of Conduct violations (as well as other alleged violations in some cases). Where the existence of a FERC investigation or audit has not been publicly announced, companies sometimes seek to settle early so that the settlement will be publicly announced at the same time as the investigation, thereby avoiding speculation in the market as to the extent of potential exposure. For similar reasons, even where the existence of a FERC audit is a matter of public record, companies often seek to resolve the matter informally, to avoid the expense and potential damage of litigation and to have some input regarding the publicly-released audit report. Although a settlement is not necessarily an admission of wrongdoing on the part of the investigated company, settlements typically nonetheless contain a recitation of facts and a list of penalties, refunds, and/or corrective measures agreed to by the company. These lists tend to gain weight with FERC audit staff in subsequent investigations. This is potentially problematic because the company settled to avoid litigation, meaning that no legally binding precedent was established. Nevertheless, these settlements sometimes appear to attach a stigma to actions that may not be contrary to the Standards of Conduct, and further to require corrective actions that in some cases go well beyond what the Standards of Conduct require. While it is too early to know the impact on the investigative process of EPAct 2005 or FERC's Enforcement Policy Statement, it seems reasonable to assume that the dramatic 127 i n c r e a s ei nF E R C sp e n a l a u t h o r i t y will increase the leverage of enforcement staff in negotiating settlements, and may lead to litigated civil (and conceivably criminal) prosecutions and the imposition of significant penalties. Of course, companies that follow the recommendations of the Enforcement Policy Statement, including establishment of a strong compliance program, stand to have such penalties reduced.
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See Chapter 3 of this Handbook for a detailed discussion of F E R C s penalty authority.
RESULTS OF SETTLEMENTS OF FERC INVESTIGATIONS

Implement/ Supplement Compliance Plans, Procedures and/or Record Keeping Subject To FERC Review X Secure Computer Systems and No New Conduct an Databases and Restrict Transactions Audit of Physical With Certain C o mp a n y s Access to Affiliates Standards Unauthorized Without FERC of Conduct Premises Approval Compliance X
Alleged Violation(s) MidAmerican Energy Co., 112 FERC 61,346 (2005) Standards of Conduct, OASIS, and open access transmission tariff ("OATT") violations (merchant function using network transmission service to import power to make possible off-system sales; transmission services provided to merchant function not available to nonaffiliates; posting of deficient organizational charts) Standards of Conduct (disclosure of non-public transmission information to affiliate and certain favored nonaffiliates; failure to strictly enforce tariff provisions; failure to properly maintain organizational charts) and failure to meet pipeline transactional reporting and posting requirements Standards of Conduct (impermissible sharing of nonpublic transportation (gas storage) information with marketing affiliate)
Monetary Payments Agreement to construct $9.2 million of previously unplanned transmission upgrades and forego recovery of all costs associated with the projects for a six-year period from the in-service date.
Suspension of MarketBased Rate Authority
Additional Training of Employees Regarding FERC s Standards of Conduct X
CenterPoint Energy Gas Transmission Co., 111 FERC 61,492 (2005).
$270,000 civil penalty
The Williams Cos., Inc., 111 FERC 61,392 (2005)
$4 million refund to storage customers and a $3.6 million civil penalty.
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190
Alleged Violation(s) Florida Power Corp., 111 FERC 61,243 (2005) ( P r o g r e s s E n e r g y ) Codes of Conduct (information exchanges, failure of units to function independently to the maximum extent practical), Standards of Conduct (potential off-OASIS communications tracks, posting deficiencies)
Monetary Payments $6.4 million refund/credit to rate payers of FPC and CP&L ($5.4 million credited to retail customers through state Fuel Adjustment Clause mechanisms and $1 million allocated to wholesale customers) plus additional refund to customers of $100,000 None
Additional Training of Employees Regarding FERC s Standards of Conduct X
Implement/ Supplement Compliance Plans, Procedures and/or Record Keeping Subject To FERC Review X
Secure Computer Systems and Databases No New Conduct an and Restrict Transactions Audit of Physical With Certain C o mp a n y s Access to Affiliates Standards Unauthorized Without FERC of Conduct Premises Approval Compliance X X
Westar Energy, Inc., 111 FERC 61,225 (2005)
Standards of Conduct (sharing of non-public transmission information, failure of WMF employee to respect independent functioning requirement, failure to post organizational information) Standards of Conduct (joint TF/WMF training exercises, joint TF/WMF meetings with customers, periodic disclosure of line outage information to WMF, and provision of nonscheduled transmission services to WMF) Standards of Conduct (potential merchant access to transmission information through meetings and access to restricted areas, incomplete organizational charts)
South Carolina Elec. & Gas Co., 111 FERC 61,217 (2005) ( SCANA )
None
Duke Energy Corp. (1/21/05) (OMOI audit report, with which Duke agreed to comply; no FERC order)
None
Alleged Violation(s) Arizona Pub. Serv. Co., 109 FERC 61,271 (2004) Standards of Conduct, OATT (marketer failure to arrange and pay for transmission service, failure to post information, failure to report emergency deviations, information sharing) Standards of Conduct, OATT (failure to post capacity information, affiliate merchant procurement of unposted capacity, potential for information sharing, failure to periodically train employees on Standards of Conduct) Natural Gas Policy Act ("NGPA"), Standards of Conduct (unauthorized communication of non-public gas storage information to an affiliate and a non-affiliate, failure to control employee access to storage information)
Monetary Payments $4 million (to be used for non-recoupable transmission upgrades and low income energy assistance programs)
Additional Training of Employees Regarding FERC s Standards of Conduct
Secure Computer Systems and Databases No New Conduct an and Restrict Transactions Audit of Physical With Certain C o mp a n y s Access to Affiliates Standards Unauthorized Without FERC of Conduct Premises Approval Compliance X
Tuscon Elec. Power Co., 109 FERC 61,272 (2004)
Refunds relating to the release of unscheduled transmission capacity (amount to be determined)
Dominion Res., Inc., 108 FERC 61,110 (2004)
$4.5 million in refunds to storage customers, $500,000 NGPA civil penalty
Northern Illinois Gas Co., 108 FERC 61,110 (2004)
NGPA, Standards of Conduct, $600,000 NGPA civil OATT (disclosure of non-public penalty gas storage information to affiliates, failure to control dissemination of non-public information)
191
192
Alleged Violation(s) Columbia Gas Transmission Corp., 108 FERC 61,110 (2004) NGPA, Standards of Conduct (unauthorized disclosure of non-public gas storage information to select customers, failure to control dissemination of information) FPA, Standards of Conduct, Codes of Conduct (posting errors, alleged preferential transactions with affiliate marketer)
Monetary Payments $2.5 million NGPA civil penalty
Implement/ Supplement Compliance Plans, Procedures and/or Record Keeping Subject To FERC Review
Secure Computer Systems and Databases No New Conduct an and Restrict Transactions Audit of Physical With Certain C o mp a n y s Access to Affiliates Standards Unauthorized Without FERC of Conduct Premises Approval Compliance
Portland Gen. Elec. Co., 105 FERC 61,302 (2003)
$8,500,000 in refunds
Cleco Corp., 104 FERC FPA, OATT, Standards of 61,125 (2003) Conduct, Codes of Conduct (unauthorized sales, undue preferences, information sharing, failure to post information, non-independent functioning, maintaining joint books, unauthorized sales by EWG) National Fuel Gas Supply Corp., 103 FERC 61,192 (2003) NGA, NGPA, Standards of Conduct (affiliate preferences, failure to post, errors in posting information)
$2,000,000 in refunds, $750,000 civil penalty
$300,000 to cover the c o s t o f F E R C sa u d i t a n d investigation
Alleged Violation(s) Idaho Power Co., 103 FERC 61,182 (2003) FPA, OATT, Standards of Conduct (incorrect affiliate use of native load priority, failure to file agreements, affiliate access to transmission information both through IT systems and face-to-face meetings, failure to post employee transfers, unauthorized assignment of contract) NGA, NGPA, Standards of Conduct (failure to post discounts, inaccurate posted data, inadequate organization charts, failure to prepare and retain written documentation, information sharing with affiliate) NGA, tariff, Standards of Conduct (unauthorized and discriminatory storage imbalance services, affiliate preference, failure to post availability of services, filing false gas storage reports) Order No. 888 comparability requirements, Standards of Conduct, and Codes of Conduct (providing marketing affiliate an interruptible firm service not provided for in tariff and not provided to nonaffiliated customers)
Monetary Payments $203,000 in refunds, $5.8 million transfer from affiliate to Idaho Power for benefit of ratepayers and $118,000 in further payments
Secure Computer Systems and Databases No New Conduct an and Restrict Transactions Audit of Physical With Certain C o mp a n y s Access to Affiliates Standards Unauthorized Without FERC of Conduct Premises Approval Compliance X X
Transcontinental Gas Pipeline Corp., 102 FERC 61,302 (2003)
$20,000,000 (NGPA violations)
Columbia Gas Transmission Corp., 93 FERC 61,057 (2000)
$27.5 million in refunds (including $1.8 million for gas imbalance penalties and $25.7 million in disgorgement payments) Disgorgement by affiliate of profits earned from the power sales supported by the off-tariff transmission service 180-day suspension of MBR sales supported by affiliate transmission
Washington Water Power Co., 83 FERC 61,282 (1998)
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194
Alleged Violation(s) Amoco Prod. Co. v. Natural Gas Pipeline Co. of America, 82 FERC 61,038, order on reh g and clarification, 82 FERC 61,300, order on reh g, reconsideration and clarification, 83 FERC 61,197 (1998). Standards of Conduct, Natural Gas Act , NGPA (affiliate preferences in transportation services, lack of independent functioning, improper information disclosure, tariff deviations)
Monetary Payments $8.8 million civil penalty ($4.4 million suspended provided that no additional violations for two years).
Secure Computer Systems and Databases No New Conduct an and Restrict Transactions Audit of Physical With Certain C o mp a n y s Access to Affiliates Standards Unauthorized Without FERC of Conduct Premises Approval Compliance Limitation of pipeline discretion in capacity auctions, to prevent affiliate preference.
Chapter 11 Codes of Conduct

NOEL SYMONS T h e F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n s ( FERC o r C o m m i s s i o n ) Codes of Conduct, together with its Standards of Conduct and market behavior rules, are the core set of interlocking rules through which FERC regulates the marketplace behavior of electric utilities and their employees. Compliance with Codes of Conduct has grown into an important focus of FERC s enforcement efforts,1 and our expectation is that the importance of these rules will continue to grow. Code of Conduct rules traditionally have been the product of case law developed in individual tariff proceedings, 2 but FERC has begun a process that is expected to result in a rulemaking.3 As the focus on these rules grows, development of effective compliance programs is becoming increasingly important,
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Symons has represented over 25 utilities and pipelines on Standards of Conduct, Code of Conduct, and affiliate sales issues. He has spoken on the topic before industry trade groups and at a FERC technical conference, where he first proposed that FERC consider the model of the Federal Sentencing Guidelines as a means to reward utilities for strong compliance programs. In the past FERC audits and investigations dealing with affiliate issues focused largely on compliance with the Standards of Conduct, but in recent years such efforts have begun to focus equally on the Codes of Conduct. See, e.g., Florida Power Corp., 111 FERC 61,243 (2005); Cleco Corp., 104 FERC 61,125 (2003); Idaho Power Co., 103 FERC 61,182 (2003). See, e.g., Standardization of Generator Interconnection Agreements and Procedures, Order No. 2003-B, 70 Fed. Reg. 265 (Jan. 4, 2005), III FERC Stats. & Regs., Regs. Preambles 3 1 , 1 7 1 , a t P1 3 7n . 5 3( 2 0 0 4 ) ( T h e C o d e o f C o n d u c t i s i m p o s e do n a c a s e -by-case basis when the Commission grants market-b a s e d r a t e a u t h o r i z a t i o n . ) . The Commission has announced, in Docket No. RM04-7, its intent to initiate a r u l e m a k i n ge x a m i n i n g t h ea d e q u a c yo ft h ec u r r e n tf o u r -prong analysis [for market-based rate authority] and whether and how it should be modified to assure that electric market-based rates are j u s t a n dr e a s o n a b l eu n d e r t h eF e d e r a l P o w e r A c t . See Market-Based Rates for Public Utilities, Initiation of Rulemaking Proceeding on Market-Based Rates and Notice of Technical Conference, 107 FERC 61,019, at P 1 (2004). One part of the four-part test is the test for affiliate abuse (id.), which can require adoption of a Code of Conduct where the potential for affiliate abuse is present. While the Commission has not yet issued a Notice of Proposed Rulemaking, it has held two technical conferences. The second of these, held on January 28, 2005, involved speakers on the topic of affiliate abuse. By notice issued February 11, 2005, the Commission invited comments on the issues that were discussed at the technical conference. Comments were submitted on March 14, 2005.
3 2 1
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particularly for companies seeking a basis for mit i g a t i o no f p e n a l t i e su n d e r F E R C s new 4 Enforcement Policy Statement. As the rulemaking process unfolds, the application of the rules may very well change. However, because that process is nascent, it is too early to even guess as to potential changes. It also is possible that the rulemaking process begun before Congress passed the Energy 5 P o l i c y A c t o f 2 0 0 5 ( EPAct 2005 ) will of necessity be a lower priority to FERC than the many new rulemakings with statutorily-created deadlines. Therefore, the following discussion is based on the existing state of the law on Codes of Conduct. I. WHAT IS A CODE OF CONDUCT?
Codes of Conduct regulate the relationship between a franchised electric utility and its power marketer and merchant plant affiliates (for purposes of this chapter we will refer to f r a n c h i s e d e l e c t r i c u t i l i t i e s a s r e g u l a t e d c o m p a n i e s a n d p o w e r m a r k e t e r a n d m e r c h a n t p l a n t 6 a f f i l i a t e s a s u n r e g u l a t e d c o m p a n i e s ) . Codes of Conduct are not required for entities with market-based rates that do not have regulated affiliates.7 While the Commission has d e v e l o p e di t s o w n d e f a u l t C o d e o f C o n d u c t , i t c o n t i n u e s t oa c c e p t a n yC o d e s o f C o n d u c t that meet its requirements. For this reason the discussion here generally uses the plural term 8 C o d e s o f C o n d u c t t o s i g n i f y d i s c u s s i o n o f g e n e r i c a p p l i c a b i l i t y . Codes of Conduct are in many respects similar to Standards of Conduct, except that they apply to a different relationship. Standards of Conduct, as discussed in Chapter 10, apply to the relationship between the Transmission Function and Energy Affiliates,9 and have a different purpose they are intended to prohibit anti-competitive behavior. Codes of Conduct have a narrower purpose: they are intended to protect captive ratepayers of
Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on E n f o r c e m e n t , 1 1 3F E R C 6 1 , 0 6 8( 2 0 0 5 ) ( Enforcement Policy Statement ) .S e ed i s c u s s i o n sin Chapters 1 and 3 of this Handbook.
5 6 4
Pub. L. No. 109-58, 119 Stat. 594 (2005).
In one instance a regulated company and an unregulated affiliate apparently are on the same side of the Code of Conduct wall, but FERC has instituted an investigation into whether that relationship should be permitted to continue. See Southern Co. Servs., Inc., 111 FERC 61,146, clarified, 112 FERC 61,015 (2005). See, e.g., TransAlta Energy Mktg. (U.S.) Inc., 112 FERC 61,335, at P 15 (2005). Additionally, Codes of Conduct are not required for unregulated entities whose only franchised utility affiliates are in Canada. See, e.g., ENMAX Energy Mktg., Inc., 109 FERC 61,143, at P 10 (2004). In addition to Codes of Conduct, FERC further regulates the relationship between regulated and unregulated affiliates by prohibiting each from selling power to the other absent a showing that the ratepayers of the regulated company will not be harmed. These affiliate sales restrictions are discussed in Chapter 7, the chapter on power sales. The Standards of Conduct are not an adequate substitute for the Code of Conduct. Minnesota Agri-Power, L.L.C., 86 FERC 61,193, at 61,675 (1999).
9 8 7
CODES OF CONDUCT
197
regulated companies from the effects of preferential dealings between a regulated company and its unregulated affiliate.10 FERC believes that when a regulated company has unregulated affiliates there is an incentive to transfer benefits from the regulated company to the unregulated affiliates,11 and to transfer costs from the unregulated company to the regulated company. 12 The same concern applies to sales of power between regulated and unregulated affiliates.13 A Code of Conduct is not intended to prevent anti-competitive conduct. Rather, a Code of Conduct is a safeguard against affiliate abuse, and therefore addresses one of the four prongs of the test for market-based rates. The other three prongs all address competitive concerns: an applicant must show that it and its affiliates, collectively, do not have, or have adequately mitigated, market power in generation and transmission, and cannot erect other barriers to entry.14 FERC will waive Code of Conduct requirements where there are no
See Carolina Power & Light Co., 97 FERC 61,063, at 61,350 (2001) ( t h e p u r p o s e o f the code of conduct is to prevent the affiliates from acting in a manner that results in a transfer of b e n e f i t s f r o mt h ef r a n c h i s e du t i l i t ya n di t s r a t e p a y e r s t ot h ep o w e r m a r k e t e r a n di t s s h a r e h o l d e r s , w h e r e a s t h e p u r p o s e o f t h e s t a n d a r d s o f c o n d u c t i s t orestrict the ability of electric utilities to give their marketing affiliates or wholesale merchant functions undue preferences over non-affiliated t r a n s m i s s i o n c u s t o m e r s ) .
10
Wh e r e. . . ap o w e r m a r k e t e r a f f i l i a t e dw i t hat r a d i t i o n a l p u b l i cu t i l i t ys e eks marketbased rate authority, the Commission requires the filing of an affiliate code of conduct to safeguard against affiliate abuse and protect against the possible diversion of benefits or profits from traditional public utilities with captive ratepay e r st oa na f f i l i a t ee n t i t yf o rt h eb e n e f i to fs h a r e h o l d e r s . Consolidated Edison Energy Mass., Inc., 90 FERC 61,225, at 61,734 (2000) (citing PPL Martins Creek, LLC, 90 FERC 61,063 (2000) and Southern Indiana Gas & Elec. Co., 77 FERC 61,024 (1996)).
11
Cross-subsidization occurs when a utility provides an affiliated power marketer with services or functions at a price that is subsidized by captive ratepayers. Heartland Energy Servs., Inc., 68 FERC 61,223, at 62,062-63 (1994). [ T ] h e r ei saconcern whenever a public utility can transact with an affiliated power marketer in such a way as to transfer benefits from a power sale from captive ratepayers to the shareholders. This can occur if the public utility can sell power under its market-based rate authorization to its affiliated power marketer at below-m a r k e t p r i c e s . Tucson Elec. Power Co., 82 FERC 61,141, at 61,525 (1998).
13
12
See, e.g., Energis Res. Inc., 79 FERC 61,170 (1997); AEP Power Mktg., Inc., 107 FERC 61,018, order on r e h g , 108 FERC 61,026 (2004) (announcing two indicative screens for assessing generation marketing power). In economic terms, the inquiry into market power in generation is a horizontal analysis, while the market power in transmission and barriers to entry analyses together comprise a horizontal analysis. The transmission market power analysis is satisfied by showing that any market power is mitigated by having an open access transmission tariff on file. See, e.g., Genesee Power Station L.P., 86 FERC 61,078 (1999). In order to meet the barriers to entry prong, the applicant must show that neither it nor its affiliates own or control any key input to power plant construction, generation, or transportation that could interfere with entry into any geographic market. See, e.g., Tucson Elec. Power Co., 80 FERC 61,236, at 61,898 (1997).
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affiliate abuse concerns either because there are no captive ratepayers or those ratepayers are protected by frozen rates15 without consideration of competitive issues.16 II. A DIFFERENT WALL
Because Codes of Conduct are similar to Standards of Conduct,17 the two often are confused. Both sets of rules restrict relationships w i t h i n c o r p o r a t e f a m i l i e s a n d e r e c t w a l l s
Affiliation with an interstate natural gas pipeline does not raise barriers to entry because, under the C o m m i s s i o n s r e q u i r e m e n t s , s u c hp i p e l i n e s m u s t o f f e r o p e n -access services on a non-discriminatory basis. See Enron Power Mktg., Inc., 65 FERC 61,305 (1993), r e h gg r a n t e do no t h e r g r o u n d s , 66 FERC 61,244 (1994). However, a market-based rate schedule can be suspended as a result of a complaint by any entity or prospective competitor whose request for gas transportation or purchase was denied, delayed, or offered under unreasonable terms, conditions or rates. See Puget Sound Energy, Inc., 86 FERC 61,088, at 61,324 (1999). If there are no captive ratepayers or if ratepayers are indifferent to the consequences of affiliate transactions, then there is no need for any measure to protect captive ratepayers, including Codes of Conduct. See, e.g., GS Elec. Generating Coop., Inc., 81 FERC 61,042 (1997) (power marketer whose utility affiliate is an electric cooperative need not submit Code of Conduct or r e s t r i c t i o n so na f f i l i a t es a l e s , b e c a u s ec o o p e r a t i v e sr a t e p a y e r sa r ei t so w n e r s , a n da n yb e n e f i t t o owners hence will also be a benefit to ratepayers such that there are no concerns regarding transfer of benefits); Exelon Generation Co., L.L.C., 93 FERC 61,140, at 61,425-26 (2000) (waiving Code of Conduct requirements when there are no captive wholesale or retail customers). Sunbury Generation, LLC, 108 FERC 61,160, at PP 39-41 (2004) (rejecting arguments that FERC should consider competitive concerns in reviewing request for waiver, but stating that it would re-evaluate its standard in the rulemaking proceeding initiated in Docket RM04-7); Baltimore Gas & Elec. Co., 91 FERC 61,270, at 61,923 (2000) (FERC decision to allow company to cancel its C o d e o f C o n d u c t w a s n o t b a s e d o n t h e e s t a b l i s h m e n t o f a c o m p e t i t i v e e n v i r o n m e n t b u t r a t h e r t h a t t h e r e w e r e a d e q u a t e s a f e g u a r d s a g a i n s t a f f i l i a t e a b u s e ) . Indeed, many of the provisions of the Code of Conduct were drawn from the original Standards of Conduct applicable to interstate natural gas pipelines under Order No. 497. Inquiry Into Alleged Anticompetitive Practices Related to Marketing Affiliates of Interstate Pipelines, Order No. 497, 53 Fed. Reg. 22,139 (June 14, 1988), FERC Stats. & Regs., Regs. Preambles 1986-1990 30,820 (1988), o r d e r o n r e h g , Order No. 497-A, 54 Fed. Reg. 52,781 (Dec. 22, 1989), FERC Stats. & Regs., Regs. Preambles 1986-1990 30,868 (1989), order extending sunset date, Order No. 497-B, 55 Fed. Reg. 53,291 (Dec. 28, 1990), FERC Stats. & Regs., Regs. Preambles 1986-1990 30,908 (1990), order extending sunset date, Order No. 497-C, 57 Fed. Reg. 9 (Jan. 2, 1992), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,934 (1991), r e h g d e n i e d , 57 Fed. Reg. 5815 (Feb. 18, 1992), 58 FERC 61,139 (1992); Tenneco Gas v. FERC, 969 F.2d 1187 (D.C. Cir. 1992) (affirmed in part and remanded in part), order on remand and extending sunset date, Order No. 497-D, 57 Fed. Reg. 58,978 (Dec. 14, 1992), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,958 (1992), order on r e h ga n de x t e n d i n gs u n s e t d a t e , Order No. 497-E, 59 Fed. Reg. 243 (Jan. 4, 1994), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,987 (1993), o r d e r d e n y i n gr e h gand granting clarification, Order No. 497-F, 59 Fed. Reg. 15,336 (Apr. 1, 1994), 66 FERC 61,347, order extending sunset date, Order No. 497-G, 59 Fed. Reg. 32,884 (June 27, 1994), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,996 (1994).
17 16 15
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between various groups of employees. The confusion arises because the two sets of rules, which are otherwise so similar, erect walls in different places, i.e., between different groups of employees. T h eS t a n d a r d so f C o n d u c t e n c o u r a g eu st ot h i n ko f a w a l l a r o u n dt h e 18 Transmission Function i.e., sealing it off from Energy Affiliates both within and outside of the regulated company. But the Codes of Conduct seal off unregulated affiliates from all functions of the regulated company including any commercial units within the regulated utility performing merchant a c t i v i t i e s .T h e w a l l f o r C o d e o f Conduct purposes is around the entire regulated company.19 In other words, while the Transmission Function of the regulated company is always on the opposite side of the wall from the unregulated affiliates, the merchant function of the regulated company will change sides depending on the set of rules being considered. For purposes of the Standards of Conduct, the merchant function of the regulated company is on the same side of the wall as the unregulated affiliates. But for purposes of the Codes of Conduct, it is on the same side of the wall as the Transmission Function. This difference is illustrated by the figures below.
Regulated Transmission Function
W A L L
Regulated Merchant Function
Unregulated Affiliate
Figure 1 Standards of Conduct Wall
S e e C h a p t e r 1 0o f t h i s H a n d b o o kf o r a d e f i n i t i o no f t h e t e r m s T r a n s m i s s i o nF u n c t i o n " a n d E n e r g y A f f i l i a t e .
18
As with the Standards of Conduct, Codes of Conduct do not apply to the relationship between unregulated affiliates. See, e.g., USGen Power Servs., L.P., 73 FERC 61,302 (1995).
19
200
Regulated Transmission Function
Regulated Merchant Function
W A L L
Figure 2 Code of Conduct Wall The distinction in wall placement between the Standards of Conduct and Codes of Conduct is a frequent source of confusion. For practical purposes, reading the two rules together often means that the regulated merchant function is effectively cut off from both the unregulated affiliates and the regulated transmission function. One way to minimize the potential that confusion will result in Code of Conduct violations is to train employees of the regulated merchant function to talk to the compliance team prior to interacting with the unregulated affiliates or the Transmission Function, and vice versa. III. REQUIREMENTS OF F E R C S DEFAULT CODE OF CONDUCT FERC s Default Code of Conduct is imposed on applicants for market-based rate authority who fail to submit a C o d e o f C o n d u c t t h a t m e e t s F E R C s requirements. Sometimes referred to as th e A p p e n d i x C C o d e o f C o n d u c t b e c a u s e i t h a s a p p e a r e di nA p p e n d i xCt o FERC orders on market-based rate applications, it has standard provisions governing separation of functions, asymmetrical pricing for affiliate sales of non-power goods and services, information sharing, and brokering of power sales.20 We address each in turn. First, however, it is important to understand that FERC routinely accepts Codes of Conduct that are different than its Default Code of Conduct. It is not feasible to discuss all the variations on Code of Conduct provisions here. While the Default Code of Conduct provides a useful proxy for discussing some of the issues that arise under Codes of Conduct, any compliance evaluation can and should start with an evaluation of the language of the actual Codes of Conduct of each entity in the corporate family with market-based rates. Each Code of Conduct within the corporate family should be evaluated, because it is not uncommon for Codes of Conduct to differ even within the corporate family. Most Codes of Conduct, however, will at least have provisions in the following categories.
FERC also has posted its Default Code of Conduct http://www.ferc.gov/industries/electric/gen-info/pm-over.asp.
20
on its
web
page:
CODES OF CONDUCT A. SEPARATION OF FUNCTIONS.
201
FERC s Default Code of Conduct requires separation of regulated and unregulated employees as follows: To the maximum extent practical, the employees of the power marketer will operate separately from the employees of the public utility.21 Thus, unlike the Standards of Conduct requirement, the Code of Conduct requirement i s f o r s e p a r a t i o n o f f u n c t i o n s t o t h e m a x i m u me x t e n t p r a c t i c a l . Unfortunately, there is little explanation of how much separation is required. At a minimum, we know that the same person cannot be used in a merchant capacity for both the regulated and unregulated companies.22 Where premises are shared, the regulated and unregulated companies must o p e r a t es e p a r a t e l y t ot h e m a x i m u m e x t e n tp o s s i b l e a n dk e e pp o w e rm a r k e t i n g information confidential. 23 1. Holding Company Structure. The Standards of Conduct clearly apply to all companies and business units within a holding company system that perform Transmission Functions or Energy Affiliate activities. Application of Codes of Conduct is not so clear. Typically a Code of Conduct is written to apply between a particular unregulated company and its regulated affiliates.24 However, it is
T h e p r o v i s i o n s i n F E R C s D e f a u l t C o d e o f C o n d u c t w e r e t a k e n f r o mA ppendix C to the order issued in Reliant Energy Shelby County, L.P., 91 FERC 61,073 (2000). To our knowledge, FERC has used substantively the same language in its Default Code of Conduct since it began using it in 1999. See Rockingham Power, L.L.C., 86 FERC 61,337 (1999) (first order using Default Code of Conduct).
21
See AEP Power Mktg., Inc., 76 FERC 61,307, at 62,515 (1996), clarified on other grounds, 84 FERC 61,270 (1998). This provision of the Default Code of Conduct appears to be patterned on Standard G of the now-superseded Standards of Conduct for natural gas pipelines with m a r k e t i n g a f f i l i a t e s , w h i c hm a n d a t e d t h a t t o t h e m a x i m u me x t e n t p r a c t i c a b l e p i p e l i n e o p e r a t i n g e m p l o y e e s a n d m a r k e t i n g a f f i l i a t e o p e r a t i n g e m p l o y e e s f u n c t i o n i n d e p e n d e n t l y o f e a c h o t h e r . A n o p e r a t i n ge m p l o y e e u n d e r t h e g a s S t a n d a r d s o f C o n d u c t w a s d e f i n e d a s a n i n d i v i d u a l w h oh a s d a y to-day duties and responsibilities for planning, directing, organizing, or carrying out gas-related operations, including gas tr a n s p o r t a t i o n , g a ss a l e so r g a sm a r k e t i n ga c t i v i t i e s . O r d e r N o . 4 9 7 -E, FERC Stats. & Regs. 30,987 at 30,996. However, FERC did not provide similar (or any) guidance o n t h e t e r m m a x i m u me x t e n t p r a c t i c a b l e i n t h e C o d e o f C o n d u c t c o n t e x t . See Energis Res., 79 FERC 61,170 at 61,796; Western Res., Inc., 74 FERC 61,136, at 61,481-82 (1996). F E R C s D e f a u l t C o d eo f C o n d u c t i s t i t l e d Statement of Policy and Code of Conduct with Respect to the Relationship Between Power Marketer and Public Utility. Rockingham Power, 86 FERC 61,337 at Appendix C. Cf. also NRG Mktg. Servs. LLC, 105 FERC 61,187, at P 27 (2003) (requiring change to Code of Conduct that had improperly identified entity to which it applied).
24 23
22
202
not always the case that every employee or officer within the holding company system that is assigned some responsibility for a regulated or unregulated company will be employed by that company. Some companies have addressed this issue by treating service company employees as if they were employed by the company to which they are assigned. 25 But the Commission has not ruled whether employees of service companies assigned to work for an affiliated merchant function must be deemed to be employees of the affiliated company for purposes of applying the Code of Conduct.26 Arguably, because the Code of Conduct is a part of a FERC-filed tariff, it should be interpreted literally to apply only to those companies identified in the Code of Conduct itself. However, the Commission has freely disregarded corporate form in assessing the reach of its jurisdiction under the Federal Power Act.27 A conservative approach to applying Code of Conduct requirements would be to adopt, by analogy, the Standards of Conduct approach of treating each employee assigned to a regulated or unregulated company as if they were employed by that company. 2. Senior Officers. Complications related to the holding company structure often arise with respect to senior officers. At times an officer at the service or holding company level will not be an officer of a regulated or unregulated subsidiary, and yet may have significant oversight responsibilities for some or all of the activities of such a subsidiary. In such cases one conservative approach would be to assess the responsibilities of the officer and treat him/her the same under the Codes of Conduct as if he/she were an officer of the subsidiary. In other cases senior holding company officers routinely are listed as officers of a wide swath of subsidiaries, including both regulated and unregulated subsidiaries. Given the functional separation requirement, the practical consequences of such an arrangement may be that holding some positions, even on a nominal basis, may restrict the permissible range of activities of the officer. For example, an officer of an unregulated affiliate should not have a
See, e.g., New England Power Co., Letter Order, Docket No. ER99-597-000 (Jan. 27, 1999) (accepting for filing Code of Conduct that, with respect to communicating market information, e f f e c t i v e l y t r e a t e d s e r v i c e c o m p a n y e m p l o y e e s s u p p o r t i n g a u t i l i t y s w h o l e s a l e s a l e s a s e m p l o y e e s o f the utility). By contrast, the Commission has made such an express determination under the Standards of Conduct. Standards of Conduct for Transmission Providers, Order No. 2004, 68 Fed. Reg. 69,134 (Dec. 11, 2003), III FERC Stats. & Regs., Regs. Preambles 31,155 (2003), order on r e h g , Order No. 2004-A, 69 Fed. Reg. 23,562 (Apr. 29, 2004), III FERC Stats. & Regs., Regs. Preambles 31,161, o r d e r o nr e h g , Order No. 2004-B, 69 Fed. Reg. 48,371 (Aug. 10, 2004), III FERC Stats. & Regs., Regs. Preambles 31,166. A compilation of these orders, including a consolidated table of contents, is available from your regular Skadden, Arps contact, or by sending an email to nsymons@skadden.com. See, e.g., Enova Corp., 79 FERC 61,107, at 61,488 (1997) (explaining basis for Commission review of mergers among entities that are parents of public utilities but are not themselves public utilities).
27 26 25
CODES OF CONDUCT
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hands-on role with respect to the merchant activities of a regulated affiliate. The potential problems of such a shared role are further exacerbated by the information sharing restriction, which, as discussed below, does not yet provide an exception for a shared senior officer to receive market information from both regulated and unregulated companies. Rather than restrict the activities of senior officers in their most important capacities, some companies have removed such individuals from officer positions that could create shared officer issues under the Codes of Conduct. B. INFORMATION SHARING RESTRICTION. F E R C s Default Code of Conduct establishes a bright line requirement to publicly disclose shared m a r k e t i n f o r m a t i o n a n di n c l u d e sa ne x t r e m e l yb r o a dd e f i n i t i o no f t h a t term: All market information shared between [Public Utility] and [Power Marketer] will be disclosed simultaneously to the public. This includes all market information, including but not limited to, any communication concerning power or transmission business, present or future, positive or negative, concrete or potential. Shared employees in a support role are not bound by this provision, but they may not serve as an improper conduit of information to non-support personnel. 28 The first sentence states that the requirement for public disclosure pertains to market information flowing in either direction b e t w e e n t h e regulated and unregulated companies.29 It also pertains to a l l market information. FERC has been reluctant to allow any relaxation of this bright line test. For example, FERC has declined to allow a utility to share with an affiliated marketer acting in a brokering capacity information about the range of prices the utility is willing to accept for its power, unless the information is simultaneously disclosed to the public.30 FERC has gone so far as to forbid companies to create an exemption to the rule for market information that is already public, because it does not want companies to judge what is public and what is not b e t t e r , i nF E R C s view, for companies to publicly disclose all market information shared between regulated and unregulated affiliates.31
28
Reliant Energy Shelby County, 91 FERC 61,073 at App. C, 2 (emphasis in original).
See section IV.A of this chapter for a discussion of Code of Conduct provisions approved by FERC that restrict the flow of market information only in one direction, from the regulated company to the unregulated company. LG&E Energy Mktg., Inc., 83 FERC 61,130, at 61,588 (1998); see also, e.g., Energy E. S. Glens Falls, LLC, 86 FERC 61,254 (1999) (finding deficient a code of conduct that prohibited t h e s h a r i n go f o n l y m a r k e t i n f o r m a t i o nc o n c e r n i n gp o s s i b l e w h o l e s a l e p o w e r t r a n s a c t i o n s b e c a u s e t h e r e q u i r e m e n t i s t o d i s c l o s e a l l s h a r e d m a r k e t i n f o r m a t i o n ) . See Cambridge Elec. Light Co., 85 FERC 61,217, at 61,898 & n.34 (1998). This was a t i g h t e n i n go f F E R C s r e q u i r e m e n t s .Ma r k e t i n f o r m a t i o ns h a r i n gr e q u i r e m e n t s o r i g i n a l l ya p p l i e dt o non-publicly available information only. See Cinergy Servs., Inc., 82 FERC 61,021, at 61,065 (1998); Horizon Energy, Co., 81 FERC 61,368, at 61,750 (1997).
31 30
29
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 1. Information Transfers to Shared Support Employees.
The only exception to the bright line rule prohibiting the sharing of market information is found in the third sentence of the provision, which allows the affiliates to 32 provide market information t o s h a r e d e m p l o y e e s i n a s u p p o r t r o l e . FERC has not clearly explained what is meant by e i t h e r s h a r e d o r s u p p o r t . This issue is similar in some respects to the issue of separation of functions, and indeed the rules on information transfers can affect organizational structures as much as, or more than, the rules on separation of functions. Any employee who is shared by regulated and unregulated companies must also be eligible t or e c e i v e m a r k e t i n f o r m a t i o n from both companies or the ability to share the employee likely is of no value. But a shared employee likely would be deemed by FERC to be an employee of both the regulated and unregulated companies for purposes of applying the Codes of Conduct. Applying the first sentence of the information sharing restriction, as an unregulated employee the shared employee could not receive market information from the regulated company, unless the information were simultaneously publicly disclosed, and vice versa. So unless the employee fits into the s h a r e de m p l o y e ei nas u p p o r t r o l e exception in the third sentence of the information sharing restriction, that employee cannot receive market information, meaning that the employee probably cannot be shared. As noted, FERC has not explained what it means by referring in the exception to the information sharing restriction to employees who are s h a r e d . Presumably shared means that the employee is performing functions for both the regulated and unregulated companies, but it is not clear whether the employee must actually be on the payroll of both, or whether it is sufficient to be on the payroll of one but performing tasks for the other,33 or to be on the payroll of a third affiliate, such as a services company, and performing tasks for both the regulated and unregulated companies. Arguably, any of these arrangements should work, particularly if one takes the view that the substance of the relationship is more important than corporate form. FERC also has not explained what it means by s u p p o r t r o l e s . The case in which FERC f i r s t a p p r o v e da ne x c e p t i o nf o r s u p p o r t e m p l o y e e sw a sb a s e db ya n a l o g yo nt h e
While there are no other exceptions to the bright line test, there is a further limitation on application of the simultaneous disclosure r e q u i r e m e n tt h a ti sc r e a t e db yl i m i t so nF E R C s j u r i s d i c t i o n .F E R C s r u l e s a p p a r e n t l yd on o t e x t e n dt oi n f o r m a t i o na b o u t b u n d l e dr e t a i l c u s t o m e r s , but do apply to information about unbundled customers. See New Energy Ventures, Inc. v. Southern Cal. Edison Co., 82 FERC 61,335 (1998) (holding that i n f o r m a t i o nc o n c e r n i n ga r e t a i l c u s t o m e r s transmission (and auxiliary service) requirement cannot be shared with the power marketing affiliate or any other affiliated marketer after the date retail access is implemented, unless such information is simultaneously shared with non-affiliates). Such an arrangement must be consistent with the rules concerning asymmetrical pricing of non-power goods and services, discussed below.
33
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Order No. 88934 Standards of Conduct, and contained a list of some types of support employees.35 Many companies look to the various types of employees that may be shared under the Standards of Conduct for guidance on interpreting the similar provision under the Code of Conduct. Clearly employees engaged in merchant functions cannot be shared.36 FERC Staff has indicated a belief that this prohibition extends to employees that are engaged in the operation of generation facilities, though it may be that they believe that it should apply only to employees engaged in economic decision-making regarding generation availability (dispatch; outage scheduling),37 which we believe would be the better interpretation, and would be consistent with the interpretation under the Standards of Conduct. The Standards of Conduct also have an exception for senior officers. However, Code of Conduct cases so far have addressed only the right to have shared support employees, leaving open the question whether FERC would approve a similar exception for shared senior officers and directors.38
Open Access Same-Time Information System (formerly Real-Time Information Networks) and Standards of Conduct, Order No. 889, 61 Fed. Reg. 21,737 (May 10, 1996), FERC Stats. & Regs., Regs. Preambles 1991-1996 3 1 , 0 3 5( 1 9 9 6 ) ( O r d e r N o . 8 8 9 ) , o r d e r o nr e h g , Order No. 889-A, 62 Fed. Reg. 12,484 (Mar. 14, 1997), FERC Stats. & Regs., Regs. Preambles 1996-2000 31,049, r e h g d e n i e d , Order No. 889-B, 62 Fed. Reg. 64,715 (Dec. 9, 1997), FERC Stats. & Regs., Regs. Preambles 1996-2000 31,253 (1997). See LG&E Energy Mktg., 83 FERC 61,130 at 61,589 (holding that power marketers and their franchised utility affiliates may have shared support personnel such as accountants, legal counsel, and data processing, that are not engaged in the daily functions of directing, organizing, and executing the business decisions of the wholesale merchant or generation functions of either company); see also Duke Power, 84 FERC 61,235, at 62,200 (1998). This was a shift in policy. Compare Horizon Energy, 81 FERC 61,368 at 62,751 (rejecting a provision that prohibited disclosure of market information only to bulk power marketing personnel, FERC declared that a code o f c o n d u c t m u s t p r o h i b i t t h e e x c h a n g e o f a n y m a r k e t i n f o r m a t i o nb e t w e e n a n y e m p l o y e e s o f a traditional public utility and its affiliated power marketer unless that information is simultaneously made available to the public).
36 35
34
See discussion of functional separation, above.
See Florida Power Corp., 111 FERC 61,243 (2005) (order approving audit report). It should be emphasized that the precedential authority of audit report findings is not clear. Arguably FERC should allow such an exception for the same reason that it does under the Standards of Conduct, namely that the absence of such an exception adversely affects the ability of senior officers and directors to engage in corporate governance functions. Absent such an interpretation companies may be faced with the anomalous outcome that they could share an officer consistent with the separation of functions requirement, but market information disclosed to that officer would have to be disclosed simultaneously to the public.
38
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 2. No-Conduit Rule.
While sh a r e ds u p p o r t e m p l o y e e sm a yr e c e i v em a r k e t i n f o r m a t i o n , t h e y m a yn o t serve as an improper conduit of information to non-s u p p o r t p e r s o n n e l . This seems to be an a d o p t i o no f t h e n o -c o n d u i t r u l ef r o mt h eOrder No. 889 Standards of Conduct, which (adapted to this context) simply provides that any shared support employee who receives market information from a regulated affiliate is prohibited from providing that information to any employee of an unregulated affiliate (other than a shared employee), and vice versa. In o t h e r w o r d s , l a u n d e r i n g o r s l e e v i n g o f m a r k e t i n f o r m a t i o nt h r ough shared employees is not allowed. 3. Market Information. The second sentence of the Default Code language provides a definition of market information. FERC has been unwilling to narrow the scope of what constitutes market information.39 To the contrary, F E R C s Default Code of Conduct broadens, for reasons that have not been explained, the definition of market information previously adopted in its cases. For example, FERC previously has stated: [I]f there is any communication between the [utility and the affiliated power marketer] concerning the utility's power or transmission businessbrokerrelated or not, present or future, positive or negative, concrete or potential, significant or slightit must be simultaneously communicated to all nonaffiliates.40 This language is very similar to the language in FERC s Default Code of Conduct, but with an important difference: FERC's early cases on the subject refer to communications concerning the utility's power o r t r a n s m i s s i o nb u s i n e s s .F E R C s Default Code of Conduct drops that important modifier, thus arguably broadening application to include communications concerning anyone's power or transmission business.41
39
See, e.g., Consolidated Edison Energy, Inc., 83 FERC 61,236, at 62,034 (1998). In this case, FERC rejected an information sharing restriction that would have applied only to any i n f o r m a t i o n a c q u i r e df r o m n o n -affiliated transmission customers or potential non-affiliated transmission customers or which is developed in the course or responding to requests for transmission o ra n c i l l a r ys e r v i c eo nO A S I S , b e c a u s em a r k e ti n f o r m a t i o ni n c l u d e s a n yc o m m u n i c a t i o n c o n c e r n i n g t h eu t i l i t y s p o w e r o r t r a n s m i s s i o nb u s i n e s s broker-related or not, present or future, p o s i t i v eo r n e g a t i v e , c o n c r e t eo r p o t e n t i a l , s i g n i f i c a n t o r s l i g h t . Id. at 62,034 (quoting UtiliCorp United, Inc., 75 FERC 61,168 at 61,557, r e h g . d e n i e d , 76 FERC 61,192 (1996)). LG&E Energy Mktg., 83 FERC 61,130 at 61,588 (quoting UtiliCorp United, Inc., 75 FERC 61,168, at 61,557 (1996) (emphasis added)); accord Consolidated Edison of N.Y., Inc., 78 FERC 61,298, at 62,284-85 (1997). F E R Ca l s oh a se x p r e s s l yf o u n da na p p l i c a n t sp r o p o s e dC o d eo fC o n d u c td e f i c i e n t because it did not contain the broader modern language. In LG&E Capital Trimble County LLC, 98 FERC 61,261, at 62,035 (2002), FERC s t a t e s : [W]e find paragraph 4 of your code of conduct deficient because it fails to contain language required by the Commission regarding the simultaneous
41 40
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Unlike the OASIS posting requirement of the Standards of Conduct, FERC has not mandated a medium for simultaneous disclosure of market information. Rather, the rule is t h a t t h e i n f o r m a t i o nm u s t b e c o m ea v a i l a b l e t on o n -affiliates at the same time it becomes 42 available to the affiliated power marketer. C. ASYMMETRICAL PRICING F E R C s Default Code of Conduct has two provisions that provide pricing terms and conditions for sales of non-power goods and services between regulated and unregulated affiliates. Because the provisions differ depending on whether the regulated company is buying from or selling to the unregulated company, they are sometimes referred to as asymmetrical pricing provisions. Sales of any non-power goods or services by [Public Utility], including sales made through its affiliated EWGs or QFs, to [Power Marketer] will be at the higher of cost or market price. Sales of any non-power goods or services by [Power Marketer] to [Public Utility] will not be at a price above market.43 These standards are intended to prevent cross-subsidization of shareholders by captive ratepayers.44 While FERC has not e x p r e s s l yd e f i n e dt h e t e r m n o n -power goods or s e r v i c e s , i th a sa p p r o v e dC o d e so fC o n d u c tt h a tt a k eap l a i nm e a n i n gi n t e r p r e t a t i o n , defining non-p o w e rg o o d sa n ds e r v i c e sa s a l l g o o d so t h e rt h a ne l e c t r i cp o w e ra n da l l services other than those services directly associated with the sale, transmission, and 45 d i s t r i b u t i o n o f e l e c t r i c p o w e r . Examples of non-p o w e r g o o d s o r s e r v i c e s a r e : s c h e d u l i n g ,
disclosure of all market information shared between LG&E Capital and its affiliated public utilities, L G & Ea n dK U .T h e a d d i t i o n a l l a n g u a g e t h a t i s n e e d e di nt h i s p a r a g r a p hi s , S u c hs h a r e dm a r k e t information includes, but is not limited to, any communication concerning power or transmission business, present or future, positive or negative, concrete or p o t e n t i a l . C u r i o u s l y , t h eq u o t ei s incorrectly attributed to the very UtiliCorp case quoted (correctly) in the 1998 LG&E case excerpted in the text. Illinova Power Mktg., Inc., 74 FERC 61,313, at 61,991 (1996). But see Florida Power Corp., 111 FERC 61,243 (approving Staff Audit Report criticizing use, as the means for simultaneous disclosure, of an electronic bulletin boards not often visited by market participants).
43
44 42
Reliant Energy Shelby County, 91 FERC 61,073 at App. C, 3,4.
See Market Responsive Energy, Inc., 85 FERC 61,435, at 62,635 (1998); AEP Power Mktg., Inc., 84 FERC 61,270 at 61,270; Southern Co. Servs., Inc., 72 FERC 61,324, at 62,407-08 (1995). San Diego Gas & Elec. Co., 83 FERC 61,199, at 61,891 (1998) (quoting the codes of conduct of Enova Energy, Inc. and San Diego Gas & Electric Co.).
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46 a c c o u n t i n g , l e g a l , o r s i m i l a r s e r v i c e s ; c o m p u t e r h a r d w a r e o r s o f t w a r e . Conversely, neither 47 a power contract nor a rate schedule is a non-power good or service.
There has been little in the way of case law discussing how one determines a m a r k e t p r i c ef o r an o n -power good or service.48 For example, FERC has not imposed detailed RFP-type requirements as it has with respect to affiliate power sales, 49 nor in our view should it, particularly because exchanges of non-power goods and services can be (and frequently are) of a de minimis nature. Whatever the process used, however, companies need to have a good explanation why the process meets the asymmetrical pricing requirement. For example, FERC has declined a request that purchases of non-power goods and services at rates approved by a state public utility commission be considered purchases at the higher of cost or market, because the applicant had not explained how the state commission would set the rate, and hence had provided no basis for concluding that the rates for sales of non-power goods and services would satisfy FERC s requirements.50 D. BROKERING OF POWER FERC imposes three specific requirements on an unregulated company seeking to broker for its regulated affiliate:51 To the extent [Power Marketer] seeks to broker power for [Public Utility]: [(i)] [Power Marketer] will offer [Public Utility's] power first; [(ii)] the arrangement between [Power Marketer] and [Public Utility] is non-exclusive;
46
Id. at 61,891 (quoting the code of conduct of AIG Trading Corporation).
See Portland Gen. Elec. Co., 81 FERC 61,374, at 62,775-6 (1997). FERC has separate rules for, and typically requires prior approval of, affiliate power sales. See Chapter 7 of this Handbook for rules governing agreements with affiliates. N o t e t h a t F E R C s r e c e n t l y -issued notice of proposed rulemaking to implement repeal of the Public Utility Holding Company Act of 1935 sought comment on whether the Commission should a p p l yt h e l o w e r o f c o s t o r m a r k e t s t a n d a r df o r t h e p r o v i s i o no f n o n -power goods and services, or s h o u l di n s t e a da d o p t t h eS e c u r i t i e sa n dE x c h a n g eC o m m i s s i o n a t c o s t s t a n d a r d . Repeal of the Public Utility Holding Company Act of 1935 and Enactment of the Public Utility Holding Company Act of 2005, Notice of Proposed Rulemaking, 112 FERC 61,300, at P 15 (2005).
48 49
47
See, e.g., Allegheny Energy Supply Co., LLC, 108 FERC 61,082 (2004). See Enron Energy Servs. Power, Inc., 81 FERC 61,267, at 62,318 (1997).
50
Note that even though power brokering itself is not a jurisdictional activity under the Federal Power Act (where the broker does not take title to the power), see, e.g., Enron Power Mktg., Inc., 65 FERC 61,305 at 62,404, unregulated affiliates wishing to broker for regulated affiliates must commit to brokering rules in the Code of Conduct. UGI Power Supply, Inc., 77 FERC 61,021, at 61,076 (1996).
51
CODES OF CONDUCT [and (iii)] [Power Marketer] will not accept any fees in conjunction with any brokering services it performs for [Public Utility].52
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T h e o f f e rf i r s t r e q u i r e m e n ti si n t ended to ensure that an unregulated company bro k e r i n gi t s r e g u l a t e da f f i l i a t e s power will not take advantage of the relationship by, in e s s e n c e , k e e p i n g t h e b e s t d e a l s f o r i t s e l f . F E R Ch a s n o t s p e c i f i e d t h e m e c h a n i c s o f t h e o f f e r f i r s t r e q u i r e m e n t s , b u t has approved at least one Code of Conduct that did so.53 One early case seemed to indicate that the requirement was broad enough to require the unregulated company to attempt to sell the regulated affiliate's power first, even if the regulated affiliate is offering a different energy product than the product being sold by the unregulated affiliate.54 The non-exclusivity requirement is straightforward: Non-affiliates must be permitted to broker the regulated company s power.55 The no-fee requirement is similarly straightforward the unregulated company may not charge the regulated company a fee for brokering. 56 However, FERC has approved Codes of Conduct under which the unregulated company receives reimbursement for salary and for overhead costs.57
52
53
Reliant Energy Shelby County, 91 FERC 61,073 at App. C, 5, 6, 7.
In LG&E Energy Mktg., Inc., 83 FERC 61,130, FERC approved a Code of Conduct (see Application of LG&E Energy Mktg., Inc. for Authorization to Amend Market-Based Rate Schedule, Docket No. ER98-1981-000 (Feb. 24, 1998, as amended on Mar. 2, 1998)) containing a m o r e d e t a i l e d o f f e r f i r s t p r o v i s i o n : [ T h e u n r e g u l a t e d c o m p a n y ] w i l l b r o k e r s a l e s o f [ t h e r e g u l a t e d c o m p a n y s ] p o w e r b e f o r e m a r k e t i n g i t s o w n p o w e r t oa u t i l i t y t h a t c o u l d b e s e r v e d b y t h e [ r e g u l a t ed company] (meaning that if the [regulated company] requests the [unregulated company] to broker power, [the unregulated company] will provide the [regulated company] with a right of first refusal on any [unregulated company] transaction that fits the [reg u l a t e dc o m p a n y s ] p a r a m e t e r s u n t i l t h e [ r e g u l a t e d c o m p a n y ] m a k e s t h e s a l e o r w i t h d r a w s i t s r e q u e s t . See Wholesale Power Servs., Inc., 72 FERC 61,284, at 62,226-27 (1995) (holding that b r o k e r m u s t f i r s t o f f e r t h e p u b l i c u t i l i t y s p o w e r r a t h e r t h a n i t s o w n p o w e r e v e n i f t h e p u b l i c u t i l i t y s power is not as firm and the rate is not at or below the rate at which power is available from the power marketing affiliate). It should be noted that that case was decided before the proliferation of power products and the tremendous increase in trading volumes in recent years.
55 54
See Southern Co. Servs., 72 FERC 61,324 at 408-09.
See Heartland, 68 FERC 61,223 at 62,065. With respect to the reverse relationship, where a regulated utility seeks to broker power for its unregulated affiliate, FERC accepts, in lieu of the no-f e e r u l e , t h a t t h e u t i l i t y w i l l c h a r g e i t s a f f i l i a t e t h e h i g h e r o f t h e u t i l i t y s c o s t s f o r t h e b r o k e r i n g service or market value. See, e.g., MEP Invs., LLC, 87 FERC 61,209, at 61,828 (1999); EWO Mktg., L.P., Letter Order, Docket No. ER02-1042-000 (Mar. 29, 2002) (approving Request for Authorization to Amend Code of Conduct of EWO Mktg., L.P., Docket No. ER02-1042-000 (Feb. 19, 2002)). See OGE Energy Res., Inc., 81 FERC 61,049 (1997) (approving Petition of OGE Energy Resources, Inc. For Blanket Authorizations, Certain Waivers, and Order Approving Market57
56
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK IV. IMPROVED CODE OF CONDUCT
FERC frequently approves a wide variety of Codes of Conduct that do not track the language of its Default Code of Conduct. F o r e x a m p l e , w eu s ea s i n g l e m o d e l Code of Conduct for our clients that differs in several respects from the FERC Default Code of Conduct:58 A. INFORMATION SHARING In perhaps the mos t s i g n i f i c a n t d i f f e r e n c e , F E R C s Default Code of Conduct prohibits c o m m u n i c a t i o n s o f m a r k e t i n f o r m a t i o n b e t w e e n t h e r e g u l a t e da n du n r e g u l a t e dc o m p a n i e s . Thus, the information sharing restriction is a two-way restriction, limiting information flows in both directions. Our model Code of Conduct contains a one-way restriction, restricting information flows only from the regulated company to the unregulated company.59 Additionally, while F E R C s Default Code of Conduct permits transfer of market information t o s h a r e d e m p l o y e e s i n a s u p p o r t r o l e , a s n o t e d a b o v e t h e r e i s l i t t l e c a s e l a wa s t o w h a t t h a t means. Our model Code of Conduct exception permits transfers of market information to all e m p l o y e e s i n s u p p o r t r o l e s ( n o t j u s t s h a r e d e m p l o y e e s ) , a n d e x p r e s s l y d e f i n e s s u c h s u p p o r t r o l e s t o i n c l u d [ e ] h u m a nr e s o u r c e s , i n f o r m a t i o nr e s o u r c e s , d a t ap r o c e s s i n g , f i n a n c e , l e g a l , accounting, and other support personnel who do not participate in directing, organizing and e x e c u t i n gt h eb u s i n e s s d e c i s i o n s o f t h ew h o l e s a l em e r c h a n t o r g e n e r a t i o nf u n c t i o n s o f t h e unregulated company. B. EMERGENCY CIRCUMSTANCES O u rm o d e lC o d eo fC o n d u c ta l l o w sd e v i a t i o n i nt h ec a s eo fe m e r g e n c y circumstances affecting s y s t e m r e l i a b i l i t y . T h e r ei sn op a r a l lel provision in the C o m m i s s i o n s Default Code of Conduct.60
Based Rate Schedule, Docket No. ER97-4345 (Aug. 25, 1997)); Wholesale Power, 72 FERC 61,284 at 62,223 n.3. T h e m o d e l C o d eo fC o nduct we use is routinely approved by FERC. See, e.g., Entergy-Koch Trading, L.P., 99 FERC 61,027 (2002); Richmond County Power, LLC, 96 FERC 61,149 (2001).
58
We w o u l dc a u t i o n , h o w e v e r , t h a t e v e nw i t ha o n e w a y r e s t r i c t i o n , F E R Cu n d e r s o m e circumstances may still question whether information flows from the unregulated to the regulated side especially routine and regular information flows are consistent with the requirement of separation of functions. Cf. Amoco Prod. Co. v. Natural Gas Pipeline Co. of Am., 82 FERC 61,300, at 62,19192 (1998) (holding, under prior natural gas Standards of Conduct upon which Code of Conduct requirements were modeled, that presence of silent pipeline employee at daily marketing meeting violated separation of functions requirement even if it did not violate one-way information sharing restriction).
59
There is, however, a similar provision under the Standards of Conduct. See 18 C.F.R. 358.4(2) (2005).
60
CODES OF CONDUCT C. BROKERING
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FERC s Default Code of Conduct provides only for brokering services offered by an unregulated company to its regulated affiliate. Our model Code of Conduct provides for brokering services offered by a regulated company to its unregulated affiliate. V. ENFORCEMENT
Intent to violate the Code of Conduct is not required for a violation to result in sanctions.61 A Code of Conduct is a part of a market-based rate tariff. As such, a violation of the Code of Conduct is a violation of the tariff, and is subject to the same punishment as any tariff violation n o wi n c l u d i n gF E R C s new authority to impose penalties of up to one million dollars per day per violation.62 Additionally, violation of the Code of Conduct is a violation of the Market Behavior Rules,63 thus potentially doubling penalties for an infraction. VI. THE PROBLEMS WITH MULTIPLE CODES OF CONDUCT Different companies within a corporate family often will have different Codes of Conduct, sometimes resulting from the companies requesting market-based rate authority at different times. There are two principle problems with multiple Codes of Conduct within a corporate family. The first is that having different Codes of Conduct means that not all are optimized. Typically many will include unnecessary provisions.64 Unfortunately, just because a provision may not be required by FERC does not mean it will not be enforced once it ends up in a company's Code of Conduct. As stated above, a Code of Conduct violation can be punished as a tariff violation. Moreover, FERC has, in one case, based assessment of
61
See The Washington Water Power Co., 83 FERC 61,282, at 62,169 (1998).
S e e C h a p t e r 3 f o r a d i s c u s s i o n o f F E R C s n e wp e n a l a u t h o r i t y . T h e e x a m p l e u s e d i n t h a t chapter to illustrate calculation of a penalty includes a Code of Conduct violation.

62
Ma r k e t B e h a v i o r R u l e 6 p r o v i d e s : S e l l e r s h a l l n o t v i o l a t e o r collude with another party i na c t i o n st h a t v i o l a t eS e l l e r sm a r k e t -based rate code of conduct or Order No. 889 standards of c o n d u c t , a s t h e y m a y b e r e v i s e d f r o mt i m e t o t i m e . See Chapter 9 of this Handbook for a discussion of the Market Behavior Rules.
63
Often such additional provisions may seem harmless because they replicate requirements that are found elsewhere. For example, some common unneeded Code of Conduct provisions are those that require the regulated company to maintain separate books and records from its unregulated affiliates; that the regulated company not grant any undue preference to its unregulated affiliate; and t h a t t h eu n r e g u l a t e da f f i l i a t em u s t t a k et r a n s m i s s i o ns e r v i c eu n d e r t h er e g u l a t e dc o m p a n y sO p e n Access Transmission Tariff. While these provisions may just restate law, as Code of Conduct provisions they are separately enforceable, meaning that conceivably they form the basis for extra penalties for the same violation. See Enforcement Policy Statement, 113 FERC 61,068 at P 14 (stating that v i o l a t i o n s o f m o r e t h a n o n e s t a t u t e , r u l e , o r r e g u l a t i o n m a y r e s u l t i n s e p a r a t e p e n a l t i e s ) .
64
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a penalty in part upon the violation of a Code of Conduct provision that is not a required provision.65 The second problem is that multiple Codes of Conduct are a compliance headache because they subject the same people performing the same conduct to different sets of rules. Take for example a holding company system with one regulated company and two unregulated companies (unregulated company A and unregulated company B). Assume that the regulated company and unregulated company A have Codes of Conduct structured like t h e m odel Skadden Code of Conduct described above, but that unregulated company B has the FERC Default Code of Conduct. That means that, among other things, the regulated c o m p a n y s C o d e o f C o n d u c t h a s a o n e w a y i n f o r m a t i o n s h a r i n g r e s t r i c t i o n , b u t u n r e g u l a t e d c o m p a n yB h a sa t w o -w a y r e s t r i c t i o n , s u c ht h a t t h ec o m p a n i e sm u s ta d o p t t h em o r e restrictive two-way restriction to avoid violations of the Code of Conduct of unregulated company B. Similarly, the companies need to analyze the other provisions of the Codes of Conduct for both the regulated company and unregulated company B, and apply the most restrictive provisions to their relationship. The relationship of the regulated utility in our example with unregulated company A is not legally saddled with the same need for a restrictive interpretation, because both companies have substantively the same Code of Conduct. However, the contrast between the relationships of the regulated company with its two unregulated affiliates raises the very real possibility perhaps even likelihood that regulated employees faced with using different sets of rules for different relationships will become confused, and apply the less restrictive rules to the relationship that should have the more restrictive rules, thereby violating the Code of Conduct. Now expand the example to the rather common situation in which the regulated company has many unregulated affiliates all with different Codes of Conduct and the potential for confusion and mistake grows exponentially. Some holding company systems with multiple Codes of Conduct address the confusion by distilling all of the Codes of Conduct, on a least-common-denominator basis, to their most restrictive provisions. However, such an approach may dampen efficiencies that may be attainable through adoption of less restrictive uniform Codes of Conduct. Another approach is for each regulated and unregulated affiliate to seek FERC approval for adoption of a uniform Code of Conduct, s u c ha st h e m o d e l C o d eo f C o n d u c t d i s c u s s e da b o v e . While there may be considerations that affect timing of filings, generally we recommend the latter approach to maximize efficiencies within permissible bounds and minimize the likelihood of confusion and error that arises with multiple Codes of Conduct.
See The Washington Water Power Co., 83 FERC 61,097 at 61,461 (1998) (show cause order); The Washington Water Power Co., 83 FERC 61,282 (enfo r c i n g u n d u ep r e f e r e n c e provision of Code of Conduct).
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CODES OF CONDUCT VII. COMPLIANCE A. COMPARATIVE COMPLIANCE: STANDARDS OF CONDUCT VS. CODES OF CONDUCT
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Our experience has been that programs for compliance with Codes of Conduct sometimes are less well-developed than those for the Standards of Conduct. The Standards of Conduct rules themselves contain compliance-oriented requirements, such as the training requirement, that can be useful tools for compliance with Codes of Conduct. But companies that have a training requirement for the Standards of Conduct, because it is required, sometimes do not provide training for Codes of Conduct. We believe that Code of Conduct training is important from a compliance perspective because effective training (a) decreases the likelihood of violations by trained employees, and (b) provides one basis for arguing that the company took reasonable steps to avoid violations in the event that a violation is discovered by FERC. In particular, we note that training is emphasized as a factor for which companies may receive c r e d i t in FERC s assessment of any penalties for violations of FERC requirements, including Code of Conduct violations. 66 Another example of an area where Code of Conduct compliance could be modeled on Standards of Conduct compliance is the requirement to develop organizational charts and job descriptions. There is no parallel Code of Conduct requirement, and yet we believe that developing and maintaining such documents is vital to a good compliance program, because without fundamentally sound employee classifications compliance is difficult.67 The bottom line is that, because of the very similar design and subject matter of the Standards of Conduct and Code of Conduct requirements, we recommend similar compliance approaches for both. Indeed, a well-designed compliance program can take advantage of the similarity of the two sets of requirements, and of the appropriate compliance measures, by consolidating the compliance program for both sets of requirements. Moreover, it is possible that the similarity between the two sets of rules will lead FERC to look by analogy to Standards of Conduct compliance requirements in determining whether companies deserve credit, under the Enforcement Policy Statement, for Code of Conduct compliance measures. B. WHAT REQUIREMENTS APPLY TO OUR COMPANIES? Assessment of compliance with Codes of Conduct necessarily starts with an understanding of the Codes of Conduct applicable within the holding company. If all Codes of Conduct within the corporate family are substantively uniform, then it will be a simple matter to make a list of requirements applicable to regulated companies and another applicable to unregulated companies. If there are multiple Codes of Conduct and a decision
66 67
Enforcement Policy Statement, 113 FERC 61,068 at P 22.
Note that the Standards of Conduct contain a requirement to post such organizational charts and job descriptions on OASIS. We are not suggesting a similar voluntary posting of charts and descriptions developed for Code of Conduct compliance, but rather that development of a system for tracking employee classification is a useful compliance tool that should not be overlooked merely because it is not required.
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has been made to replace them with more uniform Codes of Conduct through FERC filings, then it may be more efficient to perform such an assessment once the new Codes of Conduct are approved. This would allow a uniform approach. Alternatively, it will be necessary to either (a) map the various Code of Conduct requirements to the various relationships, and assess compliance for each relationship separately potentially a daunting task, or (b) develop a comprehensive list of all requirements under the various Codes of Conduct, and from that list extract the most restrictive requirements on each topic to develop a corporate family-w i d e s e t o f r u l e s o n a l e a s t c o m m o n d e n o m i n a t o r b a s i s . The best protocol for assessing compliance with Codes of Conduct will depend on the list of requirements developed through this process, and so we can do no more than offer general observations here. We do that in the context of each of the core requirements of FERC s Default Code of Conduct. C. SEPARATION OF FUNCTIONS AND INFORMATION SHARING The two most important provisions of Codes of Conduct, addressing functional separation and information sharing, have strong parallels with the related provisions of the Standards of Conduct. While not precisely the same, they are similar enough that the compliance measures for one should suffice, with little tailoring, for the other.68 Rather than repeat those discussions here, we refer you to Chapter 10, on Standards of Conduct, and the discussions there of compliance with the Independent Functioning (section I.C) and Information Sharing (section II.D) restrictions. For the most part, that same discussion applies to Codes of Conduct if one substitutes r e g u l a t e dc o m p a n y f o r T r a n s m i s s i o n P r o v i d e r , u n r e g u l a t e da f f i l i a t e f o r E n e r g ya f f i l i a t e , a n d m a r k e ti n f o r m a t i o n f o r 69 t r a n s m i s s i o n i n f o r m a t i o n . D. ASYMMETRICAL PRICING AND BROKERING Unlike the separation of functions and information sharing restrictions, the asymmetrical pricing and brokering provisions standard to most Codes of Conduct do not have parallels under the Standards of Conduct, and so we discuss compliance with those provisions here. Evaluation of compliance with these provisions of the Codes of Conduct c a n b e d i v i d e di n t o t w op a r t s : ( 1 ) a s n a p s h o t e v a l u a t i o n o f c u r r e n t c o m p l i a n c e , w h i c h w i l l be primarily substantive in nature, and (2) a forward-looking evaluation of programs and systems in place to ensure continued compliance as relevant facts inevitably change. We discuss each in turn for the asymmetrical pricing and brokering requirements.
T h e m o s t o b v i o u s a n d i m p o r t a n t d i f f e r e n c e i s , o f c o u r s e , t h a t t h e w a l l l i e s i n a d i f f e r e n t place under the Codes of Conduct than under the Standards of Conduct, as discussed above in section II of this chapter.
68
Note as well th a t b ym a k i n gt h e s es u b s t i t u t i o n sy o uh a v ed e f i n i t i o n a l l y m o v e d t h e w a l l , t h e r e b y a d d r e s s i n g t h e d i f f e r e n c e m e n t i o n e d i n t h e p r i o r f o o t n o t e .
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CODES OF CONDUCT 1. Asymmetrical Pricing a. Current Compliance
215
The asymmetrical pricing requirements are perhaps the most routinely overlooked requirements of FERC s affiliate rules. Compliance issues, which will vary widely depending on the nature of affiliate relationships, can be divided into those involving nonpower services, and those involving non-power goods. As discussed in Chapter 10 on Standards of Conduct, the process of classifying employees should include interviews with those employees, and as discussed above, that same process should be used in assessing compliance with Codes of Conduct. The process of interviewing employees for classification purposes also can be used to develop lists of any products and services that are routinely exchanged. Non-Power Services. Non-power services typically are provided in two forms: (1) services provided by a single employee, such as a shared employee, and (2) services provided company-to-company. For a single employee, if the employee is shared from an employment perspective, such that the regulated company pays the employee for services the employee provides to the regulated company, and the unregulated company pays the employee for services the employee provides to the unregulated company, arguably there is no asymmetrical pricing issue neither company is providing a service to the other.70 But if the employee is on one affiliated c o m p a n y s payroll and provides services to the other, there is a pricing issue that needs to be examined. Non-power services issues also may arise in the more traditional context where one affiliate hires another to provide a service. Arguably the market price and cost for the time put in by a single employee are one and the same, presuming that the employee is being paid a market price.71 Determining the price for a service provided other than on an hourly, per-employee basis can be more difficult. For example, market price may need to be determined by obtaining a price quote from a third party providing such services. If a quote is needed, there is no guidance as to whether a single quote would be sufficient. Arguably, the more expensive a good or service, the more important it is to obtain more than one quote. Non-Power Goods. Non-power goods issues can arise frequently, and can range from de minimis items such as office supplies to high-cost items like turbines, emissions allowances, and fuel. If a transferred item was recently purchased at a market price, then there may be a defensible position that the market price and cost are one and the same, thus making the pricing rules symmetrical and easier to apply. However, such an argument will be more difficult to make if the goods in question have been in inventory for some time, or if
The same result occurs if the employee is a service company employee whose salary and overhead are allocated to each company based on work performed. Note that calculation of the cost of employee time probably should include both salary and overhead costs. Cf. OGE Energy, 81 FERC 61,049; Wholesale Power, 72 FERC 61,284 ( a p p r o v i n g n o -f e e b r o k e r i n g f o r r egulated affiliate by unregulated affiliate in which the unregulated company receives reimbursement for salary and for overhead costs).
71 70
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the market for the goods in question is volatile. In such cases, the regulated company's costs can be determined if records have been kept. Determination of market price will depend on the good. Some items, such as emissions allowances or fuels, may have a reference index price.72 Others may require contacting vendors to provide reference prices. Finally, it should be noted that information about some non-power goods or services also may be market information, such that disclosing it between regulated and unregulated affiliates (other than to shared support employees) would require simultaneous disclosure to the public. As discussed above, the definition of market information is very broad. b. Going Forward Compliance Going forward, a program for compliance with the asymmetrical pricing provisions could have three components, discussed here in turn. 1) Identifying and evaluating proposed transfers of non-power goods and services before they occur. As part of training on Codes of Conduct, employees of regulated and unregulated affiliates should be trained on the asymmetrical pricing rules, and told to check with compliance personnel before making a transfer. Additionally, as noted above we recommend development of a list of routine transfers of non-power goods and services during the employee interviews that occur as part of the process of classifying employees. Any existing approval process or checklist for such transfers should be amended to require the sign-off of compliance personnel, and companies may wish to consider creating an approval process for transfers on the list that are not currently subject to such a process. Compliance review of a proposed transfer should determine whether, consistent with the information sharing provisions of the applicable Codes of Conduct, the transfer will require simultaneous disclosure to the public of any market information. 2) Documenting compliance. Compliance personnel should retain documentation substantiating price determinations. Compliance with asymmetrical pricing requirements may be difficult to substantiate in an after-the-fact audit unless records are kept. A purchase receipt or invoice may substantiate the cost basis for an item or service, while a quote letter or note to file documenting a telephone conversation with a vendor may substantiate a market price determination. 3) Periodic Review. The process described here is dependent in part on maintaining an accurate list of the non-power goods and services routinely transferred between regulated and unregulated affiliates. Therefore, we recommend periodic review of the list.
Note, however, that even an index price should be geographically relevant. Cf. Richmond County, 96 FERC 61,149 at 61,642-43.
72
CODES OF CONDUCT 2. Brokering73 a. Current Compliance
217
Evaluation of current compliance with the brokering requirements in many cases will be simple: Because of commercial sensitivity to the information disclosure requirements, the burden of the brokering requirements, and the proliferation of third-party brokers in the market, many companies do not have brokering relationships between regulated and unregulated companies. However, when compliance personnel interview personnel for purposes of job classifications, they should inquire as well whether there is a brokering relationship. If so, evaluation of compliance requires a look at each of the criteria for brokering, as well as the information disclosure requirement. O f f e rF i r s t R e q u i r e m e n t . Determination of compliance with the offer first requirement will turn largely on interviews of the broker/traders of the unregulated company, who should be asked whether they are offering the product of the regulated company before offering their own power. Spot checks also may be performed of recorded phone logs, and to compare like transactions of like products within the same timeframe entered into by the unregulated company on behalf of itself and its regulated affiliate. While evaluation of such transactions may not be conclusive,74 it is possible that FERC auditors investigating compliance with brokering requirements would look for suspicious patterns. Traders also should be warned that co u n t e r p a r t i e sa r ea w a r eo fF E R C s requirements (often having received the same training themselves) and may report activity they deem suspicious to FERC. Non-Exclusivity. Compliance with the non-exclusivity requirement can be ascertained by determining whether the regulated company uses unaffiliated brokers in addition to its affiliates. If there is no record of use of third party brokers on a relatively contemporaneous basis, compliance personnel should determine, through interviews and perhaps evaluation of recorded phone logs, whether the regulated utility has been declining brokering offers. If so, there is a potential compliance issue, though it may be hard to determine objectively why such offers were declined. In such circumstances, compliance personnel should remind regulated traders of the non-exclusivity requirement, and encourage them to use such non-affiliated brokers for a meaningful portion of the purchases and sales brokered on behalf of the regulated company.
Note that this discussion pertains to compliance with the requirements for brokering by an unregulated company for a regulated affiliate. The requirements for brokering by a regulated company for its unregulated affiliate are different, but the general approach to compliance would be similar. T o d a y s m a r k e t i s s ol i q u i da n dv o l a t i l e t h a t t h e b e s t p r i c e i nt h e m o m e n t t h a t a d e a l i s struck on behalf of a regulated company may be beaten by a competing offer a moment later. Conversely, the regulated company may choose not to strike on a particular price, and it may turn out that that price was the best price, with the regulated company settling for a worse price later in the day.
74
73
218
No Fee. Once it is determined that a brokering service is offered, compliance with this requirement can be assessed by interviewing the employees performing and receiving the services and accountants responsible for keeping the books of the respective companies. Information Sharing. Provision of brokering service requires an exchange of market information, such as price, quantity and term. As noted, market information disclosed between regulated and unregulated affiliates in a brokering context must be simultaneously made available to the public.75 As a practical matter, this is a difficult requirement to meet, unless the communication between regulated and unregulated companies occurs in a public forum in the first place (e.g., on an electronic bulletin board), or the information is posted publicly before the communication. It is not clear that immediately-after-the-fact disclosure would meet the simultaneous disclosure requirement. b. Going Forward Compliance A program for going forward compliance with the brokering requirements could have three components: 1) Effective training. This is particularly important for the regulated traders who may make brokering requests. 2) E s t a b l i s h m e n t o f a p r i o r a p p r o v a l p r o c e s s f o r f i r s t -t i m e b r o k e r i n g a r r angements between regulated and unregulated affiliates. Once a brokering relationship is established it may be used frequently. Moreover, decisions on brokered transactions sometimes need to be made quickly. Thus, it likely would be impractical for compliance personnel to become involved in reviewing brokered transactions on a real-time basis. However, companies could require that compliance personnel be contacted the first time a regulated company makes a brokering arrangement with the unregulated affiliate, to confirm that a sound structure for compliance is in place, and that the affected employees on both sides understand the rules. 3) Periodic Review. Periodic reviews could be conducted to determine (1) whether affiliate brokering relationships known to compliance personnel continue to meet the brokering requirements, and (2) whether new affiliate brokering relationships have been established, and if so whether such relationships meet the requirements.
75
See LG&E Energy Mktg., 83 FERC 61,130 at 61,588.
Chapter 12 Interlocking Directorate Rules

KATHRYN KAVANAGH BARAN INTRODUCTION S e c t i o n3 0 5 ( b )o ft h eF e d e r a lP o w e rA c t( F P A )p r o h i b i t sa p e r s o nf r o m concurrently serving as an officer or director of a public utility and as an officer or director of certain other specified commercial entities, unless that person first obtains approval to do so f r o mt h eF e d e r a l E n e r g yR e g u l a t o r yC o m m i s s i o n( F E R C o r t h e C o m m i s s i o n ). 1 The t h r e e s p e c i f i ct y p e s o f i n t e r l o c k s t h a t r e q u i r ep r i o r a p p r o v a l f r o mF E R Ca r et h o s eo f ( a ) two public utilities; (b) a public utility and a firm that is authorized to underwrite securities of a public utility; or (c) a public utility and a company supplying that public utility with electrical equipment.2 Furthermore, section 305(c) and Part 46 of F E R C sr e g u l a t i o n s impose certain mandatory reporting requirements for broad categories of individuals who hold an executive position with a public utility and also serve in an executive capacity with any of the broad spectrum of other entities delineated in section 305(c)(2). This long-standing but little-known statutory restriction on the ability of public utility officers and directors to hold concurrent positions of executive authority in multiple business entities was originally adopted in the Federal Power Act of 1935. The provision reflects C o n g r e s s e f f o r t s a t t h a t t i m e t o t h w a r t w h a t i t p e r c e i v e d t o b e t h e c o n c e n t r a t i o n o f e c o n o m i c power in the hands of a few individuals. The restriction is designed both to create transparency in the official busi n e s s r e l a t i o n s h i p s t h a t i n s i d e r s s h a r e a n d t o p e r m i t F E R Ct o eliminate interlocking relationships t h a t i t b e l i e v e sm i g h t l e a dt oal a c ko f a r m sl e n g t h dealings, breach of fiduciary duties, and other unwanted behavior.3 Although section 305(b) has not historically created significant compliance issues, FERC recently has emphasized the
1
Associate, Skadden, Arps, Slate, Meagher & Flom LLP.
16 U.S.C. 825d(b) (2004). This chapter does not address FPA section 305(a), which provides that officers or directors of a public utility may not receive anything of value as a result of t h e s a l e o f a n y s e c u r i t y o f t h e p u b l i c u t i l i t y a n d p r o h i b i t s o f f i c e r s o r d i r e c t o r s f r o m p a r t i c i p a t [ i n g ] i n the making or paying of any dividends of such public utility from any funds properly included in [a] c a p i t a l a c c o u n t . 1 6U . S . C . 8 2 5 d ( a ) .F P As e c t i o n3 0 5 ( a ) r a i s e s s e p a r a t e c o m p l i a n c e i s s u e s i n t h e context of mergers and other transactions that are addressed in Chapter 5 of this Handbook. 16 U.S.C. 825d(b). The broad requirement for prior authorization to hold concurrent positions in public utilities and firms authorized to underwrite public utility securities was softened by the creation of certain statutory exceptions in 1999. See infra note 49 and accompanying text. Wi t h r e s p e c t t o S e c t i o n 3 0 5 ( b ) , C o n g r e s s e x h i b i t e d a r e l e n t l e s s i n t e r e s t i n , b o r d e r i n go n an obsession with, the evils of concentration of economic power in the hands of a few individuals. It recognized that the conflicts of interest stemming from the presence of the same few persons on boards of companies with intersecting interests generated subtle and difficult-to-prove failures in the a r m s l e n g t h b a r g a i n i n g p r o c e s s . Hatch v. FERC, 654 F.2d 825, 831 (D.C. Cir. 1981).
3 2
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importance of timely compliance with its requirements4 and has implemented a new final rule revising its regulations governing approvals under FPA section 305(b).5 I. LEGAL REQUIREMENTS
A. AUTHORIZATION IN ADVANCE OF HOLDING THE INTERLOCK IS REQUIRED

6 As a general matter, se c t i o n3 0 5 ( b )i sc o n s i d e r e dt ob e p r o p h y l a c t i ci nn a t u r e . FERC does not inquire as to whether the individual seeking to serve concurrently as an officer or director of a public utility and one of the other designated companies has (or does not have) knowledge of, involvement in, or influence over transactions by or with either of the interlocking entities.7 Assurances that no abuses will occur, or that past transactions between the companies have been de minimus, are considered immaterial. 8 The bottom line is that FERC is concerned with future opportunities for mischief that have the inherent potential to occur because of the concurrent relationships.9
Without the required Commission approval, a proscribed interlock is considered to be unlawful ab initio.10 Although only the individual person bears the burden of complying with section 305(b), it is only prudent that the public utility take the lead in insuring that each officer and director is in full compliance with the restrictions in order to avoid the public embarrassment of non-compliance and/or the need for an officer or director of the public utility to take corrective measures, such as resigning involuntarily from one of the interlocked executive positions, and to protect its officers and directors from the risk of being assessed significant civil penalties.11
4
See Federal Power Act Section 305(B) Obligations, Order Advising Public Utilities and Their Officers and Directors of Federal Power Act Section 305(B) Obligations, 107 FERC 61,290, at P2( 2 0 0 4 ) ( S e c t i o n3 0 5 ( B ) O b l i g a t i o n sO r d e r ) ( w a r n i n gt h a t t h e C o m m i s s i o ni sc o n c e r n e d a b o u t t h e t i m e l i n e s s o f a p p l i c a t i o n s a n d a d v i s i n g t h e o f f i c e r s a n d d i r e c t o r s o f p u b l i c u t i l i t i e s o f t h e i r compliance obligations). Commission Authorization to Hold Interlocking Directorates, Order No. 664, 112 FERC 6 1 , 2 9 8 , 7 0 F e d . R e g . 5 5 , 7 1 7 ( 2 0 0 5 ) ( S e p t . 2 3 , 2 0 0 5 ) ( O r d e r N o . 6 6 4 ) , reh'g pending.
6 7 8 5
Hatch, 654 F.2d at 832. Id.
Id. ( [ T ] h eC o m m i s s i o nn e e dn o t a p p r o v ea l l a p p l i c a t i o n s f o r i n t e r l o c k s s i m ply on the a s s u r a n c e , e v e n i f t h a t a s s u r a n c e i s b a c k e d b y f a v o r a b l e h i s t o r y , t h a t n o s u c h a b u s e s w i l l o c c u r . ) . See James S. Pagnetelli, 1 1 1F E R C 6 1 , 4 9 6a t P1( 2 0 0 5 ) ( s t a t i n gt h a t t h e u n d e r l y i n g purpose of Section 305(b) . . . [is] the potential for a d v e r s ee f f e c t s o np u b l i co r p r i v a t ei n t e r e s t s ) (emphasis added).
9 10 11
Id. at P 13.
A t l e a s t o n e F E R CC o m m i s s i o n e r h a s e x p r e s s e dt h es a m e s e n t i m e n t : [ A l t h o u g h ] t h i s prohibition applies to the individual . . . I personally hold the utility responsible. I believe that knowing the Federal Power Act, the utility should undertake due diligence to ensure that no potential member of the Board is offered a position with the Board unless there is no conflict of interest. This is a duty that the utility owes no t o n l yt oi t s c o n s u m e r s b u t a l s ot oi t s s h a r e h o l d e r s . See Federal
INTERLOCKING DIRECTORATES
221
The statute requires prior authorization to hold otherwise proscribed interlocking positions, and the Commission recently has revised its regulations in order to make clear that Commission approval is required in advance of a person assuming certain interlocking executive duties.12 This issue of prior approvals has been a matter of particular interest to Chairman Kelliher.13 Until the recent revisions, the Commission's regulations had stated that an application for Section 305(b) approval must be made within 30 days of election or appointment to the interlocking position. 14 During the rulemaking proceeding leading up to the new rules many commenters urged the Commission to maintain the status quo 30-day grace period for applications for approval. The Commission declined, declaring that to do so 15 w o u l d f r u s t r a t e s e c t i o n 3 0 5 ( b ) a n d i t s p r o p h y l a c t i c n a t u r e . In fact the new rule appears a l m o s t d r a c o n i a n : t h eC o m m i s s i o nw i l l a u t o m a t i c a l l yd e n ya l l l a t e -filed applications for 16 a u t h o r i z a t i o nt oh o l di n t e r l o c k i n gp o s i t i o n s . This bright-line enforcement stance has the potential for harsh consequences for interlocking officers and directors within a public utility holding company system unless a compliance program is in place to help ensure that advance authorizations are sought and received. The recently-repealed Public Utility Holding Company Act ( P U H C A ) i n c l u d e da provision similar to Section 305(b) of the FPA. That provision, section 17(c), prohibited interlocking directorates between holding companies or their subsidiaries and a financial underwriter unless specifically excepted by a Securities a n dE x c h a n g e C o m m i s s i o n ( S E C ) 17 rule or regulation. However, section 17(c) of PUHCA and section 305(b) of the FPA do not address identical interlocking directorate positions.18 Thus, persons seeking to hold an
E n e r g y R e g u l a t o r y C o m m i s s i o n O p e n P u b l i c Me e t i n g , A p r . 1 4 , 2 0 0 4 , T r a n s c r i p t a t 6 3 ( T r a n s c r i p t ) (statement of Commissioner Kelly).

12 13
Order No. 664 at P 30.
See Douglas R. Oberhelman, 109 FERC 6 1 , 3 3 2( 2 0 0 4 ) ( K e l l i h e r , c o n c u r r i n g ) ( I t i s hard to see how this Commission can apply Section 305(b) in a prophylactic manner if it chooses to do so after-the-f a c t . F o r t h e s e r e a s o n s , I b e l i e v e t h a t t h i s C o m m i s s i o n h a s a d u t y u n d e r t h e s t atute to f i n d l a t e f i l e r s i n v i o l a t i o n o f S e c t i o n 3 0 5 ( b ) . . . . [ T ] h e p l a i n l a n g u a g e o f t h e s t a t u t e g o v e r n s . ) .
14 15 16
18 C.F.R. 45.3 (2005). Order No. 664 at P 30.
Id. On the other hand, if the Commission fails to act within 60 days of the filing of a completed application to hold interlocking positions, the application will be deemed granted. Id. at P 38.
17 18
15 U.S.C. 79q(c).
See American Elec. Power Co., 54 FERC 61,336, at 62,080 n.15 (1991). For example, certain interlocking positions covered under Section 305(b) of the FPA, e.g., the holding of positions as an officer or director of a public utility and an officer or director of any company supplying electrical equipment to such public utility, were not subject to section 17(c) of PUHCA. In addition, officers or directors of a registered public utility holding company, or any of its subsidiaries, could have been subject to section 17(c) of PUHCA (and SEC Rule 70) but not necessarily be subject to section 305(b) of the FPA, unless such holding company or subsidiary company is a public utility as defined in section 201(e) of the FPA. Id.
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interlock enumerated in Section 305(b) must i n d e p e n d e n t l y s e e k F E R C s a u t h o r i z a t i o n , e v e n 19 if that interlock had been otherwise authorized by the SEC. B. POSITIONS AFFECTED BY THE RULE As noted, there are three specific types of interlocks that require pre-authorization from FERC. These are officer, director, or other executive positions that involve: (a) two public utilities; (b) a public utility and a firm that is authorized to underwrite securities of a public utility (with certain statutory exceptions); or (c) a public utility and a company supplying that public utility with electrical equipment.20 The rule is not triggered by any p a r t i c u l a r j o bt i t l e s , b u t r a t h e r b ya n ye x e c u t i v ep o s i t i o nt h a t i s i n v e s t e dw i t he x e c u t i v e a u t h o r i t y s u c h t h a t t h e y w o u l d f u n c t i o n a l l y f a l l w i t h i n t h e s c o p e o f t h e rule. 21 1. Interlocks Between Two Public Utilities Section 305(b) of the FPA prohibits an officer or director of a public utility from concurrently serving as an officer or director of another public utility unless FERC determines that the dual service will not adversely affect public or private interests.22 Although interlocks involving two unaffiliated public utilities are strongly disfavored, as discussed below, FERC generally will automatically authorize interlocks between two or more affiliated public utilities after an informational filing made with the Commission. 23 The new rule, however, explicitly requires that the informational filing be made before the interlock is created.24 a. Automatic Authorization for Certain Affiliates Automatic authorization may be obtained for interlocking officers or directors where the public utilities at issue are part of the same public utility holding company system. 25 The Commission reasons that (a) a holding company, by virtue of its control of the voting stock of its subsidiary public utilities, already controls those utilities; (b) close federal and state regulation of holding companies and their subsidiary public utilities means that these
19 20 21 22 23 24 25
Id. at 62,080-81. 16 U.S.C. 825d(b). 18 C.F.R. 45.2(a). Pagnetelli, 111 FERC 61,496 at P 9. Id. at P 13. Order No. 664 at P 24.
See 18 C.F.R. 45.9; see also Automatic Authorization for Holding Certain Positions that Require Commission Approval under Section 305(b) of the Federal Power Act , Order No. 446, 51 Fed. Reg. 4900 (Feb. 10, 1986), FERC Stats. & Regs. 1986-1990, Regulations Preambles 3 0 , 6 8 6 , a t 3 0 , 1 2 8( 1 9 8 6 ) ( h e r e i n a f t e r O r d e r N o . 4 4 6 ) ( T h e C o m m i s s i o n . . . e l i m i n a t e [ s ] w h a t i t believes to be an unnecessary filing burden on certain categories of applicants . . . to hold interlocking positions which have traditionally been approved routinely because they present no potential threat to p u b l i c o r p r i v a t e i n t e r e s t s w i t h i n t h e m e a n i n g o f t h e F P A . ) .
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interlocks would not impede regulation; (c) interlocking directorships within a holding company family could enable increased efficiency and economically sound operations; (d) case-specific approvals of these interlocks are not necessary to ensure full public disclosure; and (e) there have been no indications that holding of these types of interlocks has led to the types of abuses that Section 305(b) was intended to address.26 In these affiliate approval cases, the specific test for whether the public utilities at issue are part of the same public utility holding company is whether the same holding company owns, directly or indirectly, t h a t p e r c e n t a g e o f e a c h u t i l i t y s s t o c k ( o f w h a t e v e r c l a s s o r c l a s s e s ) w h i c h i s r e q u i r e d b y e a c h 27 u t i l i t y s b y -laws to elect directors. T h e C o m m i s s i o n s r e g u l a t i o n s a l s oa u t h o r i z e i n t e r l o c k s b e t w e e n t w oo r more public utilities if the public utilities are affiliated (that is, one owns, wholly or in part, the other) and t h e o w n e d p u b l i cu t i l i t yp r o v i d e s , a si t sp r i m a r yb u s i n e s s , t r a n s m i s s i o ns e r v i c et oo r 28 e l e c t r i cp o w e r t ot h e o w n e r p u b l i c u t i l i t y . In these situations, the Commission reasons t h a t ( a ) t h e o w n e d p u b l i cu t i l i t i e s a r ee s s e n t i a l l yp a r t n e r s h i p s o f o w n e r p u b l i cu t i l i t i e s w i t hs p e c i f i cc o n t r o l a r r a n g e m e n t ss p e l l e do u t i nt h ei n i t i a l a g r e e m e n t s ; ( b ) t h e o w n e d public utilities were created for the purpose of taking advantage of economies of scale and sharing the risks of financing, constructing, and operating facilities for the joint benefit of the 29 o w n e r p u b l i c u t i l i t i e s ; a n d( c ) h i s t o r i c a l l ys u c hi n t e r l o c k s h a db e e na p p r o v e dr o u t i n e l y . As noted earlier, however, the Commission now requires that individuals seeking to hold interlocks between affiliated public utilities obtain authorization before the interlock is created. b. Previously Granted Waivers for Holders of Market-based rate Authority In the past, the Commission typically waived the full requirements of Part 45 of its regulations (that is, requirements to file for authorization to hold otherwise prohibited interlocks) for those individuals who held executive positions with public utilities that had been granted authority to sell power at market-based rates.30 For those individuals, FERC used to accept a b b r e v i a t e d f i l i n g s, giving essentially automatic authorization, in orders
26 27
Pagnetelli, 111 FERC 61,496 at P 13 (citing Order No. 446 at 30,129-30).
See 18 C.F.R. 45.9 (a) (1). It is possible, however, that FERC could find an interlock between a Transmission Provider and an Energy Affiliate problematic under Order No. 2004, but it has never done so and it may be that FERC would address such an issue as part of Order No. 2004 compliance rather than as part of an interlock application under Section 305(b).
28
Pagnetelli, 111 FERC 61,496 at P 13 (citing 18 C.F.R. 45.9 (2004) and Order No. Id. (citing Order No. 446 at 30,131). See generally Order No. 664 at 32-34.
446).
29 30
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granting market-based rates.31 FERC maintains ongoing jurisdiction to review its continued approval of the affected interlocks.32 F E R C sn e wi n t e r l o c k i n go f f i c e r a n dd i r e c t o r r u l ed i s c o n t i n u e st h eC o m m i s s i o n s 33 policy of granting these waivers. But individuals who are currently authorized to hold interlocking positions under the previous policy are not required to refile in order to continue to hold an existing interlocking position.34 However, if that individual assumes a different or a d d i t i o n a li n t e r l o c k i n gp o s i t i o n , t h ef u l l c o m p l i m e n to ft h eC o m m i s s i o n sr e quirements under Section 45 must be met.35 c. Interlocks Between Non-Affiliates are Strongly Disfavored In contrast to the automatic approvals for interlocks involving affiliated public utilities, interlocks between unaffiliated public utilities generally are c o n s i d e r e d n o t t o b e a n 36 a c c e p t a b l e o p t i o n . The Commission finds interlocks between unaffiliated public utilities t ob e j u s t s u c hr e l a t i o n s h i p sw h i c h[ S e c t i o n3 0 5 ( b ) o f ] t h eF e d e r a l P o w e r A c t s e e k st o 37 c u r b . These situations, the Commission reasons, may result in competitive abuses in the course of two unaffiliated public utilities (a) competing to serve customers; (b) bidding for services; or (c) striving to attract new customers.38 The Commission has dismissed the possibility of conditionally approving this type of interlock with limitations that would quarantine certain decision-making.39 The Commission has concluded that it is not possible t of a s h i o ne f f e c t i v e , e n f o r c e a b l er e s t r i c t i o n st ol i m i ta ni n d i v i d u a l sp a r t i c i p a t i o ni nt h e business decisions of potentially competing companies, nor would it be beneficial for the public utilities to do so. 40
Id.; see also, e.g., Calpine Newark, LLC, Letter Order, Docket No. ER04-831-000 (July 21, 2004) (citing Citizens Energy Corp., 35 FERC 61,198 (1986)). See, e.g., San Manuel Power Co. LLC, 96 FERC 61,089, at 61,371, and Ordering Paragraph (E) (2001).
33 34 35 36 32
31
Order No. 664 at P 34. Id. at P 36. Id.
See Robert G. Schoenberger, 110 FERC 61,197 (2005) (denying authorization to hold interlocking positions as Director of Southwest Power Pool and President, Chairman of the Board, and Chief Executive Officer of Unitil Corporation, Fitchburg Gas and Electric Light Company and Unitil Energy Systems, Inc.); see also Paul H. Henson, 51 FERC 6 1 , 1 0 4( 1 9 9 0 )( interlocks between unaffiliated public utilities would create potential conflicts of interest because the holders of s u c h i n t e r l o c k s w o u l d b e p e r f o r m i n g d u t i e s f o r p o t e n t i a l l y c o m p e t i n g s y s t e m s . ). Pagnetelli, 111 FERC 61,496 at P 14 (quoting Willis C. Fitkin, 7 FERC 61,291, at 61,626 (1979)).
38 39 40 37
Id. at P 16. Id. Id. at P 17.
225
Although F E R Ch a s ,o nr a r eo c c a s i o na n du n d e r u n i q u ef a c t o r s o r s p e c i a l c i r c u m s t a n c e s , a u t h o r i z e di n d i v i d u a l s t oh o l di n t e r l o c k i n gp o s i t i o n s w h e nt w o unaffiliated public utilities were involved, 41 it also has denied authorization for an interlocking position between two unaffiliated public utilities, even where one of the entities was a not-for-profit Regional Transmission Organization.42 In that case, the applicant had been unanimously selected by an independent nominating committee to be a Director of the not-for-profit ISO 43 N e wE n g l a n d , I n c . ( I S O -N E ) . The interlock at issue involved executive positions held in a public utility located in Arizona, a geographic region remote from ISO-NE.44 In addition, according to the application, the ISO-N EC o d eo f C o n d u c t p r o v i d e se f f e c t i v ep r o t e c t i o n 45 a g a i n s t e v e nt h ep e r c e p t i o no f t h ec o n c e r n s t h a t S e c t i o n3 0 5 ( b ) i s d e s i g n e dt oa d d r e s s . T h e C o m m i s s i o n s d e n i a l of the application suggests that the Commission, at least for now, will not take a more flexible approach with regard to proposed interlocks that involve nonprofit ISOs or RTOs. 2. Interlocks Between a Public Utility and a Firm Authorized to Underwrite Securities of a Public Utility Section 305(b) also prohibits an officer or director of a public utility from concurrently serving as an officer or director of a bank, trust company, banking association, or firm authorized to underwrite or participate in the marketing of public utility securities unless FERC determines that the dual service does not adversely affect private or public interests.46 To be within the scope of the rule, a company (or a member of its corporate family) need only be authorized by law to underwrite securities.47 It is irrelevant whether the
See Pedro J. Pizarro, 110 FERC 62,105 (2005) (authorizing an interlocking relationship where, under the bankruptcy reorganization plan of California Power Exchange Corporation, Southern California Edison Company could designate one member on the CalPX Board of Directors); William L. Cyr, 106 FERC 62,012 (2004) (allowing an officer of a public utility to be d i r e c t o ro fa ni n d e p e n d e n ts y s t e m a d m i n i s t r a t o r( I S A )b e c a u s et h eC o m m i s s i o n -approved governance structure of the ISA required the public utility representative, the ISA was electrically isolated from the rest of the region, the board of the ISA permitted no one stakeholder to dominate decision-making, and the ISA does not maintain operational control of transmission facilities); see also California Power Exchange Corp., 103 FERC 61,001 (2003) (finding special circumstances because interlocking directors were to provide expert guidance regarding wind-up matters prior to the CalPX dissolution). See Pagnetelli, 111 FERC 61,496 at PP 18-19; accord Robert G. Schoenberger, 110 FERC 61,197 (2005).
43 44 45 46 47 42
41
Pagnetelli, 111 FERC 61,496 at P 6. Id. at P 7. Id. 16 U.S.C. 825d(b). See Norman Barker, 53 FERC 61,223 (1990).
226
firm actively participates as a securities underwriter,48 or actually underwrites securities to the particular public utility as to which the interlock arises. Section 305(b) was amended in 1999 to address this particular prohibition.49 Today, interlocking directorates between a public utility and a bank or securities firm are permissible without FERC authorization if any one of the following circumstances are present: (a) the bank, trust company, banking association, or firm is under consideration by the public utility to underwrite or participate in the marketing of securities of the public utility, and the person s e r v i n ga s a n i n s i d e r w i l l n o t p a r t i c i p a t e i na n yd e l i b e r a t i o n s o r d i s c u s s i o n s o f the public utility regarding the selection; (b) the bank, trust company, banking association, or firm of which the person is an officer or director does not engage in the underwriting of, or participate in the marketing of, securities of the public utility of which the person holds the position of officer or director; (c) the public utility for which the person serves or proposes to serve as an officer or director selects underwriters by competitive procedures; or (d) the issuance of securities of the public utility for which the person serves or proposes to serve as an officer or director has been approved by all Federal and State regulatory agencies having jurisdiction over the issuance.50 In short, a person who meets at least one of the conditions of Section 305(b)(2)(B) falls outside of the scope of the prohibition and he or she need not obtain FERC authorization to hold the interlocking positions.51 However, if a person does not meet one of the providedfor exceptions, his or her holding of an interlocking position would require advance Commission authorization in accordance with the statute and the regulations. 3. Interlocks Between a Public Utility and a Company Supplying that Public Utility with Electrical Equipment Section 305(b) prohibits an officer or director of a public utility from concurrently serving as an officer or director of any company supplying electrical equipment to that public utility unless FERC determines that the dual service does not adversely affect private or public interests.52 Of the three types of interlocking relationships described by Section 305(b), only this one is triggered by a transaction between the two entities that would form the interlock. T h eC o m m i s s i o n sr e g u l a t i o n sd e f i n e e l e c t r i c a le q u i p m e n t a s a n ya p p a r a t u s , device, integral component, or integral part used in an activity which is electrically, electronically, mechanically, or by legal prescription necessary to the process of generation, 53 t r a n s m i s s i o n , o r d i s t r i b u t i o no f e l e c t r i ce n e r g y . An obvious example of a supplier of
48 49
Id.
See Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999, Pub. L. No. 106-102.
50 51 52 53
16 U.S.C. 825d(b)(2)(B). See James R. Lientz, Jr., 93 FERC 61,007 (2000). 16 U.S.C. 825d(b). 18 C.F.R. 46.2(f).
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electrical equipment would be a company that produces power production turbines.54 However, FERC has recently indicated that electrical equipment could also include certain types of computer software55 and even telephone equipment.56 It is also worth noting that the Commission has attributed the activities of a firm to its corporate parent and to its affiliates for purposes of establishing section 305(b) jurisdiction.57 Specifically, in this regard, an indirect supplier of electrical equipment has been considered to fall within the purview of section 305(b).58 In other words, Commission authorization may be required before an individual may hold an interlocking directorate between a public utility and another corporate entity if the second entity is merely affiliated with a supplier of electrical equipment to the public utility. In the past, FERC has granted authorization for the holding of interlocking positions with a company supplying electrical equipment when the historical transactions between the companies have been de minimis.59 In making this determination, FERC has considered various factors, including calculating past transactions both (a) as a percentage of the p u r c h a s i n gu t i l i t y s t o t a l e x p e n d i t u r e s f o r m a t e r i a l s a n ds u p p l i e s , and (b) as a percentage of 60 t h e s e l l i n g s u p p l i e r s t o t a l s a l e s f o r a g i v e n y e a r . Recent case law suggests that FERC now a l s o t a k e s i n t o c o n s i d e r a t i o n t h e l i k e l i h o o d o r a m o u n t o f a n y f u t u r e s a l e s f r o mt h e e l e c t r i c a l 61 s u p p l i e r t ot h ep u b l i cu t i l i t y . According t oF E R C , a s ag e n e r a l p r i n c i p l e , i n t e r l o c k i n g directorates involving a public utility and an electrical equipment supplier should not be permitted where the supplier is in a position to furnish an appreciable amount of the
54 55
See, e.g., Eliot G. Protsch, 99 FERC 62,059 (2002). See also 18 C.F.R. 46.2(f) n.1.
See Michael J. Chesser, 107 FERC 6 1 , 0 2 1( 2 0 0 4 ) ( I t r o nm a n u f a c t u r e s a n ds u p p l i e s electrical equipment, as defined in 18 C.F.R. 46.2(f) (2003), such as meter reading-related e q u i p m e n t a n d s o f t w a r e ) . T h e s o f t w a r e e q u i p m e n t a t i s s u e i n Chesser involved computer analyses related, in part, to distributed asset optimization, field service optimization, and mobile workforce management systems. Id. at PP 10-11. See James H. Hance, Jr., 111 FERC 62,152 (2005) (authorizing holding of interlocking positions as Director of both Duke Energy Corporation and Sprint Corporation).
57 58 56
See Jeffrey J. Burdge, 54 FERC 62,076, at 63,135 and n.2 (1991) (collecting cases). Id. (citing John J Haehl, Jr., unreported order issued December 22, 1976, Docket No. ID-
1788). See, e.g., Alan J. Fohrer, 106 FERC 6 2 , 0 1 1( 2 0 0 4 ) .S i g n i f i c a n t l y , h o w e v e r , t h e m e r e presence of de minimis sales by the electrical equipment supplier to the utility does not ensure that the applicant meets the required showing that neither public nor private interests will be adversely a f f e c t e da n dt h u sg u a r a n t e et h a t t h eC o m m i s s i o nw i l l a u t h o r i z et h ea p p l i c a n t sr e q u e s t t oh o l d i n g interlocking positions. See Oberhelman, 109 FERC 61,332 at P 8.
59
See Kenneth L. Way, 88 FERC 62,057 (1999). Cf. Oberhelman, 109 FERC 61,332 at P 11 (finding application for authorization did not include information necessary for the Commission t o a d e q u a t e l y e v a l u a t e t h e b u s i n e s s r e l a t i o n s h i p b e t w e e n t h e s e t w o e n t i t i e s . ) . Compare Roger Agnelli, 109 FERC 62,109 (2004) (demonstrating types of information provided for successful authorization) with Oberhelman, 109 FERC 61,332 at P 3 n.3 and P 11 n.13 (explaining the types of omitted information that caused FERC to reject request for authorization).
61
60
228
62 electrical equipment in any categ o r yp u r c h a s e db yap u b l i cu t i l i t y . The quantum that c o n s t i t u t e s a n a p p r e c i a b l e a m o u n t h a s y e t t o b e i d e n t i f i e d .
FERC typically conditions its authorization for an electrical supplier interlock with the requirement that, on or before April 30 of every year during which the positions are held, the officer or director will submit a report disclosing the nature and dollar amount of any purchase by the public utility of any electrical equipment or related services supplied by the electrical equipment company, whether such transactions are made directly or indirectly through wholesale or retail suppliers or any other intermediary. 63 Similar filings are also required by Section 305(c), as discussed below. 4. Public Utility Holding Companies If the interlocking relationship is between a public utility and a public utility holding company, and that holding company itself is not a public utility, FERC approval is not required.64 A holding company that is not a public utility under the FPA is not considered to be within the jurisdiction of Section 305(b).65 C. REPORTING REQUIREMENTS Once an individual has received Commission authorization to hold an interlock otherwise prohibited by Section 305(b) as a result of a petition, or through the automatic approval processes noted above he or she must file FERC Form 561 every year by April 30.66 Furthermore, under FPA Section 305(c), many other individuals similarly have an obligation to file this form with FERC on April 30, even if they do not hold an interlocking directorship described in Section 305(b). Section 3 0 5 ( c ) a n dP a r t 4 6o f F E R C s r e g u l a t i o n s impose certain mandatory reporting requirements for broad categories of individuals who hold an executive position67 with a public utility and also serve in an executive capacity with any other entity delineated in Section 305(c)(2).68 Thus, a person who holds an executive position with a public utility must file FERC Form 561 with FERC if he or she also holds an
See Oberhelman, 109 FERC 61,332 at P 7 (emphasis added); see also Chesser, 107 FERC 61,021 at P 12. See James H. Hance, Jr., 111 FERC 62,152 (2005); see also Fohrer, 106 FERC 62,011 at P 2.
64 65 66 63 62
See Schoenberger, 110 FERC 61,197 at n.4 (2005). Herbert H. Tate, Jr., 106 FERC 62,156 (2004).
See 18 C.F.R. 46.6; see also, e.g., Electronic Filing of Interlocking Positions and Twenty Largest Purchasers Information, Notice of Proposed Rulemaking, 111 FERC 61,278 (2005) ( h e r e i n a f t e r E l e c t r o n i c F i l i n g N O P R ) . As with the rules governing interlocks, the associated rules governing this broader reporting requirement are not triggered by any particular job titles, but rather by the positions being i n v e s t e d w i t h e x e c u t i v e a u t h o r i t y s u c h t hat they would functionally fall within the scope of the rule. 18 C.F.R. 45.2(a).
68 67
16 U.S.C. 825d(c); 18 C.F.R. 46.
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executive position with (a) any investment bank, bank holding company, foreign bank or subsidiary thereof doing business in the United States; (b) any insurance company; (c) any other organization primarily engaged in the business of providing financial services or credit, a mutual savings bank, or a savings and loan association; (d) any company, firm or organization which is authorized by law to underwrite or participate in the marketing of securities of a public utility; (e) any company, firm, or organization which produces or supplies electrical equipment or coal, natural gas, oil, nuclear fuel, or other fuel, for the use of any public utility; (f) any company, firm, or organization which, during any of the three calendar years immediately preceding the filing date, purchased (for purposes other than for resale) one of the 20 largest annual amounts of electric energy sold by such public utility (or by any public utility which is part of the same holding company system); (g) any entity referred to in Section 305(b), as already discussed; or (h) any company, firm or organization which is controlled by any company, firm or organization referred to in the list above. FERC has stated that it utilizes the data collected under this reporting requirement as part of its oversight of proscribed interlocking positions.69 Finally , s e p a r a t ef r o ma n di na d d i t i o nt ot h ei n d i v i d u a l s r e p o r t i n go b l i g a t i o n sj u s t described, Section 305(c) requires each public utility to provide to FERC on January 30 of each year a list of customers and their business addresses that are the top 20 largest purchasers of electric energy, measured in kilowatt hours sold, for purposes other than resale, during any of three preceding calendar years.70 Again, FERC has stated that it uses this i n f o r m a t i o n , i nc o n j u n c t i o nw i t ht h eo t h e r d a t ac o l l e c t e d , t oi d e n t i fy potential conflicts of 71 i n t e r e s t . D. PENALTIES FOR VIOLATIONS To date, there is no record of FERC ever having assessed a penalty for violations of Sections 305(b) or 305(c).72 Notably, however, since the Energy Policy Act of 2005 was signed into law on August 8, 2005, the Commission now has available to it the ability to assess civil penalties of up to $1,000,000 for each day that a person or public utility violates either provision.73 Prior to enactment of EPAct 2005, Chairman Kelliher indicated it would b ea p p r o p r i a t et ol e v yp e n a l t i e s f o r a ni n d i v i d u a l s f a i l u r et oo b t a i nC o m m i s s i o na p p r o v a l prior to assuming an interlock proscribed by Section 305(b).74 Public utilities, and
69
See Instructions for Completing Annual Report of Interlocking Positions (Form 561), http://www.ferc.gov/docs-filing/hard-fil-elec.asp#skipnavsub ( Form 561 ); see also Electronic Filing NOPR, 111 FERC 61,278.
70 71 72
18 C.F.R. 46.3; see also Form 561. See Electronic Filing NOPR, slip op. at 7.
See T r a n s c r i p t a t 6 2( Ms . Ma r l e t t e : Weh a v en o t , t om yk n o w l e d g ee v e r a s s e s s e da p e n a l t y f o r v i o l a t i n g [ S e c t i o n 3 0 5 ( b ) ] . ) .
73 74
16 U.S.C. 825o-1 (2005).
See Schoenberger, 110 FERC 61,197 (denying authorization to hold interlocking p o s i t i o n s )( K e l l i h e r ,c o n c u r r i n g )( s t a t i n g , w h i l et h eC o m m i s s i o nd o e sn o th a v ec i v i lp e n a l t y autho r i t y ,In o t et h a tMr .S c h o e n b e r g e r sf a i l u r et oo b t a i np r i o rC o m m i s s i o na p p r o v a lf o r
230
individuals who hold executive positions with public utilities, should therefore be keenly aware of the Commission's heightened concern about the timeliness of applications for approvals.75 Notwithstanding formal sanctions, an individual who holds a Section 305(b) interlock without prior Commission authorization also could face the embarrassment and potential financial consequences of unwinding the relationship because approval has been or is likely to be denied.76 II. COMPLIANCE ISSUES AND PROCEDURES
As a general matter, public utilities should take several steps in order to assure that their officers and directors are in compliance with the prohibitions of Section 305(b) and the reporting requirements of Section 305(c): One approach would be for each public utility to p r e p a r ead a t ab a s et h a t c o r r e s p o n d st ot h ec a t e g o r i e sl i s t e di nF E R C s Instructions for Completing Annual Report of Interlocking Positions.77 That is, the name of each candidate who intends to hold an executive position with the public utility would be entered into the data base, along with (a) the position(s) held with that public utility, (b) any executive positions held with any other entity, and (c) a description of the type of entity in which the additional executive positions are held. Additional elements of this data base should include updated information regarding (1) all companies that supply the public utility with electrical e q u i p m e n t ; a n d ( 2 ) t h e c u r r e n t t o p 2 0 c u s t o m e r s . If any of the additional executive positions are associated with an entity that falls into one of the many categories included in the Section 305(c) reporting obligation, the individual would be responsible for filing FERC Form 561 by April 30 of each year;
concurrently holding interlocking directorate positions is the type of violation for which the i m p o s i t i o n o f a p e n a l t y w o u l d b e a p p r o p r i a t e . ) . See Section 305(B) Obligations Order, 107 FERC 61,290 at P 2. Before the statutory civil penalties were available, Chairman Kelliher further demonstrated his keen interest in this issue by requesting that the FERC Office of General Counsel review whether the Commission may have authority to require someone who assumes an interlocking directorate position without FERC approval to disgorge any compensation gained during the relevant period of unauthorized service. See Transcript at 61-62 (Commissioner Kelliher and Ms. Marlette discussing remedies). See generally Chesser, 107 FERC 61,021. In this case the Commission denied an i n d i v i d u a l s a p p l i c a t i o nf o r a u t h o r i z a t i o nt oc o n t i n u e t oh o l db o a r dp o s i t i o n s o f b o t ha p u b l i c u t i l i t y and its electrical equipment supplier. In response, the applicant (a) tendered his immediate resignation as a director of the electrical equipment supplier; (b) divested all personal financial interests in the electrical equipment supplier; (c) appointed a compliance officer for the public utility to assure timely compliance with all applicable regulations and reporting requirements; (d) committed t oc a u s eac o m p r e h e n s i v er e v i e wo ft h ep u b l i cu t i l i t y sc o m p l i a n c ew i t hC o m m i s s i o nr u l e sa n d regulations for all business units; and (e) filed a letter with the Commission, explaining the remedial efforts, expressing his regret for failing to seek prior approval from the Commission, and assuring the Commission of his intent to comply in the future. See Letter from Michael J. Chesser, CEO, Great Plains Energy, to Magalie R. Salas, Secretary, FERC, (April 22, 2004) (on file in Docket No. ID3966-001).
77 76 75
See Form 561.
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If any of the additional executive positions are with another public utility, investigation should be made to determine whether the two public utilities are part of the same public utility holding company such that automatic authorization for the interlocks may be obtained from FERC with an informational filing; If any of the additional executive positions are with another public utility and do not fall into the affiliate exception, legal advice should be obtained as to how best to proceed; If any of the additional executive positions are with a bank or a securities firm, and any of the conditions listed in Section 305(b)(2)(B) are met, FERC approval likely is not required for the interlock, but if the conditions of Section 305(b)(2)(B) are not met, FERC approval would be required; If any of the additional executive positions are with a company listed as a supplier of electrical equipment, FERC approval may be required under Section 305(b) and legal advice should be obtained as to how best to proceed. F E R C sr e c e n t h e i g h t e n e di n t e r e s t i nS e c t i o n3 0 5 ( b ) c o m p l i a n c e , coupled with its 78 Enforcement Policy Statement, strongly indicates that public utilities should conduct this type of due diligence with regard to their current officers and directors to determine whether these individuals might presently hold interlocking positions with other companies that could be construed to fall within the scope of the rule. Once the initial due diligence check has been completed, a "going forward" process to help ensure continued compliance will be needed. This could include (1) training of executives and compliance staff on the requirements of Section 305(b) and (c); (2) a requirement to check for interlock issues before any new officer or director is appointed; (3) a requirement for officers and directors to report to compliance personnel any new executive positions with other companies before taking such positions; and (4) follow-up periodic interviews with officers and directors to determine whether any unreported changes have occurred.
Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on E n f o r c e m e n t , 1 1 3F E R C 6 1 , 0 6 8( 2 0 0 5 ) ( Enforcement Policy Statement ) .See Chapter 1 of this Handbook for a discussion of creation of a compliance program consistent with the Enforcement Policy Statement, and Chapter 3 for a discussion of FERC's application of its new penal authority under the Enforcement Policy Statement.
78
Chapter 13 An Overview of Hydropower Regulation

JUNE BROADSTONE Since 1920, the year Congress enacted what today is known as Part I of the Federal Power Act ( Part Ior FPA ), the Federal Energy Regulatory Commission ( FERCor Commission ) (preceded by the Federal Power Commission) has been the agency charged with the responsibility of overseeing the non-federal development, operation and safety of our nation's hydropower resources.1 In simple terms, the Commission regulates hydropower development under the FPA by issuing a license to a qualified entity for a certain term of years and, thereafter, by systematically monitoring and, if necessary, enforcing a licensee's compliance with the terms and conditions of its license. Little more can be said about hydropower regulation that is simple, however. It is a highly technical and complex area and any detailed treatment of it is well beyond the scope of what we could hope to address here.2 For this reason, we provide only an overview in this chapter of the regulatory scheme under Part I of the FPA, and touch upon the more common licensing questions and compliance issues we are called upon to address.
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden, Ms. Broadstone served as an electric and gas pipeline rate trial attorney, Special Assistant to the General Counsel, and Special Assistant to the Vice Chairman of the Federal Energy Regulatory Commission. She would like to thank her colleagues Robert Warnement and Paul Silverman for their contributions to this chapter. Part I of the FPA, presently codified at 16 U.S.C. 791 to 823c, was originally enacted as the Federal Water Power Act in 1920. In 1935, Congress broadened the scope and significance of t h e C o m m i s s i o n s r e s p o n s i b i l i t i e s b ye n a c t i n gP a r t I I o f t h e F P A , 1 6U . S . C . 824 to 824n, Part III of the FPA, 16 U.S.C. 825 to 825u, and the Natural Gas Act, 15 U.S.C. 717 to 717z, thereby charging the Commission with the regulation of public utilities engaged in interstate sales or transmission of electricity and interstate sales or transmission of natural gas, and by granting the Commission enforcement powers over both hydropower licensees and public utilities. Since 1935, the provisions of FPA Part I have been amended further by the Public Utility Regulatory Policies Act of 1978, the Electric Consumers Protection Act of 1986, the Energy Policy Act of 1992 and, most recently by, the Energy Policy Act of 2005, Pub. L. No. 109-5 8 , 1 1 9S t a t . 5 9 4( 2 0 0 5 ) ( E P A c t 2 0 0 5 ) . Recognizing this complexity and the need to make its regulatory processes more understandable to applicants, licensees and exemptees, the Commission Staff developed and published three handbooks, a Licensing Handbook, a guide to Environmental Analysis and Preparation, and a Compliance Handbook. These handbooks can be found on the hydropower s e c t i o n o f t h e C o m m i s s i o n s w e b s i t e a t h t t p : / w w w . f e r c . g o v / i n d u s t r i e s / h y d r o p o w e r . a s p .
2 1
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK I. FERC JURISDICTION UNDER FPA PART I
The jurisdictional reach of the Commission under Part I of the FPA is extensive. A FERC license is required to develop, construct, own, or operate, and maintain any nonfederal hydroelectric power project that (i) affects the navigable waterways of the United States or the interests of interstate or foreign commerce, (ii) occupies any part of the public lands or reservations of the United States, or (iii) uses the surplus water or water power of a federal government dam.3 A notable exception to the Commission's jurisdiction relates to projects developed under rights granted prior to the date of enactment (June 10, 1920); these projects may or may not be subject to the licensing requirements of Part I. 4 Certain jurisdictional determinations are mandatory, must be made prior to commencement of construction and require the filing of a declaration of intention with the Commission. 5 Any significant modification of an existing project (whether exempt from Part I or licensed) requires prior Commission authorization. 6 Finally, FERC has jurisdiction over transfers of direct ownership interests in jurisdictional projects, license transfers, and other rights connected with a project or license and, in most cases, prior FERC approval is required to make such transfers.7 Part I declares it unlawful for any person, municipality, or State to either (i) develop o r o w n a n d o p e r a t e a h y d r o e l e c t r i c p r o j e c t t h a t f a l l s w i t h i nt h e s c o p e o f F E R C s j u r i s d i c t i o n without first having obtained a license or an exemption from the Commission, or (ii) fail to comply with the terms and conditions of any permit, license, or exemption issued by the Commission.8 Violations of Part I may result in the imposition of civil or criminal penalties.9
See 16 U.S.C. 797(e); accord id. 817(1). The reader should bear in mind that a licensee (or exemptee) under Part I of the FPA m a y a l s o b e s u b j e c t t o r e g u l a t i o n a s a p u b l i c u t i l i t y under Part II of the FPA. See 16 U.S.C. 824 (e). In fact, that is quite likely to be the case unless (1) it is the type of entity specifically excluded from regulation under Part II (e.g., a municipality or an electric cooperative, see 16 U.S.C. 824 (f)); or (2) it satisfies the size (30 megawatts or less) and o t h e r c r i t e r i a n e c e s s a r y t o q u a l i f y a s a q u a l i f y i n g s m a l l p o w e r p r o d u c t i o n f a c i l i t y ( Q F ) u n d e r t h e C o m m i s s i o n sr e g u l a t i o n s .AQ Fo f t his kind is exempt from most public utility-type regulation under Part II. QF criteria and associated exemptions are discussed in Chapter 14 of this Handbook. 16 U.S.C. 816. For example, a license is not required if the project is operated pursuant to a permit or a valid existing right-of-way issued prior to June 10, 1920, and the permit was issued by a federal authority. See Niagara Falls Power Co. v. FPC, 137 F.2d 787 (2d Cir. 1943). See 16 U.S.C. 817; see also FPC v. Union Elec. Co., 381 U.S. 90 (1965) (party proposing to locate a project on a non-navigable stream was required to declare its intention to the Commission so that a determination could be made on whether a license was necessary). See 16 U.S.C. 817; see also 18 C.F.R. 4.200-4.202 (establishing filing requirements applicable to various types of activities that trigger the need to seek a license amendment).
7 8 9 6 5 4 3
See 16 U.S.C. 801. See id. 817.
See id. 823b(c) (authorizing FERC to impose a penalty of $10,000 per day per violation of any rule or regulation under Part I); id. 825n(a) (authorizing a $1,000 civil penalty for willful
HYDROPOWER REGULATION
235
In addition to assessing civil penalties of up to $10,000 per day for violations of the terms or conditions of a permit, license or exemption (or FERC s r u l e s o r o r d e r s ),10 the Commission may revoke a license or exemption for knowing violations by a licensee or exemptee.11 II. PERMITS, EXEMPTIONS AND LICENSES FERC authorizes the development of hydroelectric projects by issuing preliminary permits, exemptions, and licenses to qualified persons or entities. FERC oversees the development, construction, operation, and maintenance of hydroelectric projects by monitoring (or enforcing) compliance by its permittees, exemptees and licensees with the terms and conditions of the permit, exemption, or license. Permits, licenses, or exemptions may only be issued to United States citizens, corporations organized under the laws of any State, States, or municipalities. 12 Any person, corporation, State, or municipality that has any proprietary right necessary to construct, operate or maintain a project must be named on a license, or identified in a permit (e.g., joint developers or lessors under sale-leasebacks). States and municipalities are afforded a statutory preference in the permitting and licensing of previously unlicensed hydroelectric projects.13 Existing licensees are afforded statutory protections in the relicensing of their hydroelectric projects.14 Preliminary permits are granted for the purpose of allowing a permittee to study a site and to secure a priority for its license application.15 The FPA specifies that the term of a preliminary permit may not exceed three years.16 A preliminary permit is not a necessary precondition to filing a license application. However, it may gain a permittee the status of a priority applicantand thus create a strategic advantage at the licensing stage if a similar
violations of orders or subpoenas issued under Part I); id. 825o(a) (permitting fines of up to $1 million and five years imprisonment for knowing and willful acts or omissions in violation of rules or orders issued under Part I); id. 825o(b) (permitting fines of up to $25,000 per day for knowing and willful violations of rules or orders issued under Part I by FERC or the Secretary of the A r m y i n a d d i t i o nt oa n yo t h e rp e n a l t i e sp r o v i d e db yl a w ) ;see also 18 C.F.R. 385.1501-385.1511 (describing the procedures for assessing civil penalties under Part I).
10 11 12 13
See 16 U.S.C. 823b(c). See id. 823b(b). See id. 797(e).
See id. 800(a). In general, the Commission must award a permit or an original license t oS t a t eo rm u n i c i p a l e n t i t i e si f t h e i rp l a n sa r e e q u a l l yw e l l a d a p t e d c o m p a r e dt ot h ep l a n so f competing private applicants. Id. See id. 808(a)(2). In general, in a relicensing proceeding where an existing licensee and another entity have filed competing applications, FERC may not award the new license to the other e n t i t y w h e n t h e r e a r e i n s i g n i f i c a n t d i f f e r e n c e s b e t w e e n t h e c o m p e t i n g d e v e l o p m e n t p l a n s . Id. F E R C s principal regulations governing preliminary permits are set forth at 18 C.F.R. 4.80-4.84.
15 16 14
See 16 U.S.C. 798.
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entity files a competing application to develop a project utilizing all (or part of) the same water resources.17 Exemptions from licensing are available for low head hydroelectric projects (5 MW or less) and small conduit hydroelectric projects.18 Only the person that owns or controls all proprietary rights necessary to construct, operate, or maintain an exempt project may apply for an exemption. An exemption can be desirable because it can substantially reduce the burden of ongoing regulatory compliance by exempting the holder from all (or part) of Part I o f t h e F P Aa n d F E R C s i m p l e m e n t i n gr e g u l ations. However, an exempt party is required to comply with certain standard (or case specific) terms and conditions. 19 In addition, an exemption does not provide an exemptee the same level of rights and protections afforded to licensees, and it may be revoked by the Commission.20 Licenses may be issued by FERC for a term not to exceed 50 years. 21 Under current Commission policy, and depending on size and other project characteristics, licenses are issued for a term of either 30, 40 or 50 years.22 At the expiration of a license term, FERC may take a number of different actions: upon application, it may reissue the license to the existing licensee, grant a license to a new licensee, permit the existing licensee to continue to operate the project on an annual basis, or permit the license to be surrendered on such terms as are agreed to by the licensee and the Commission.23
All things being equal, FERC will favor the license application of a priority permittee. See 18 C.F.R 4.37(c) (establishing the rules of preference FERC will apply in a variety of competitive permitting and licensing circumstances). See 18 C.F.R. 4.31(b)-(c); see also id. 4.30(28) (defining small conduit hydroelectric facilities); id. 4.30(29) (defining small hydroelectric power projects). FERC recently determined in a case involving experimental underwater turbines that an exemption to the license requirement could be granted in a case where (1) the technology in question is experimental, (2) the proposed facilities are to be utilized for a short period for the purpose of conducting studies necessary to prepare a license application, and (3) power generated from the test project will not be transmitted into, or displace power from, the national electric energy grid. Verdant Power LLC, 111 FERC 61,024 (2005). Standard terms and conditions for small conduit exemptions are set forth at 18 C.F.R 4.94. The terms and conditions for small hydro projects are case specific. See id. 4.103. For example, after a license is issued it subsequently may be altered by the Commission only for the reasons and in the manner prescribed by section 6 of the FPA. 16 U.S.C. 799. Exemptions do not enjoy this statutory protection. As such, a third party may seek and be granted a license by the Commission for an existing exempt project. A licensee (unlike an exemptee) may acquire the project from the exemptee by exercising the right granted to licensees to acquire all property necessary for the development, operation and maintenance of a project through the federal power of eminent domain under section 21 of the FPA. Id. 814.
21 22 23 20 19 18
17
See id. 799, 808. See Consumers Power Co., 68 FERC 61,077 (1994).
Licensing issues are addressed principally in section 15 of the FPA. 16 U.S.C. 808. In addition, and although invoked rarely, section 14 governs the rights of the Federal government to take
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F E R C s t r a d i t i o n a l a n dn e wl i c e n s i n g p r o c e s s , t h e n e e df o r o n g o i n g c o m p l i a n c e w i t h the terms and conditions of a license, and certain events that may trigger the need to seek further Commission approvals, or an amendment of a license, are discussed in more detail below. III. LICENSING PROCESS AND STANDARDS FOR ISSUANCE F E R C s l i c e n s i n gp r o c e s s i s laborious, expensive and, at least historically, has been fraught with lengthy delays. The reasons for this are readily apparent from even a cursory description of the statutory framework under which its licensing decisions are made. Licenses issued by the Commission must (i) be best adapted to a comprehensive plan for the affected waterways for all beneficial public uses; (ii) include provisions for the protection of fish and wildlife and other beneficial public uses; and (iii) give environmental values, including fish and wildlife and recreation, equal consideration with hydropower development.24 FERC must include any timely conditions mandated by the federal agency that manages a federal reservation (e.g., the Department of Agriculture or the Department of Interior), if any part of the project is located on federal land, 25 as well as conditions relating to fishways timely prescribed by the Department of Interior or the Department of
over a project at the expiration of the term of a license, and preserves the rights of the Federal government and any State or municipality to take over a project during the term of the license. Id. 807. Id. 797, 803, 807, 808, 811 (providing the principal framework for the licensing and the relicensing of projects). Commission decisions also must be made in compliance with the requirements of the National Environmental Policy Act of 1969, 42 U.S.C. 4321 et seq. Other statutes may be implicated as well, including, for example, the Endangered Species Act, 16 U.S.C. 1531 et seq; the Costal Zone Management Act, 16 U.S.C. 1451 et seq; and the National Historic Preservation Act, 16 U.S.C. 470-470w-6. See FPA 4(e), 16 U.S.C. 797(e). EPAct 2005 amended FPA section 4(e) and added a new FPA section 33(a) that attempts to streamline this aspect of the licensing process. See EPAct 2005 241(a), 119 Stat. at 674 (amending 16 U.S.C. 797(e)); id. 241(c), 119 Stat. at 675-77 (adding 16 U.S.C. 823d). Prior to these amendments, the Department of the Interior, the Department of Commerce, and the Department of Agriculture could all independently impose mandatory conditions on license approvals. Section 4(e), as amended, now provides for a single, jointly conducted, expedited trial-type procedure. See 16 U.S.C. 797(e). Section 33(a) allows a license applicant (or any other party) to propose an alternative to any such condition, and requires the Secretary of the relevant department to accept the alternative if it is supported by substantial e v i d e n c e , a n d i f i t p r o v i d e s f o r t h e a d e q u a t e p r o t e c t i o n a n d u t i l i z a t i o n o f t h e a f f ected site area, and e i t h e r ( a ) c o s t [ s ] s i g n i f i c a n t l y l e s s t o i m p l e m e n t o r ( b ) r e s u l t s i n i m p r o v e d o p e r a t i o n o f t h e p r o j e c t w o r k s f o r e l e c t r i c i t y p r o d u c t i o n . 1 6 U . S . C . 8 2 3 d ( a ) .
25 24
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Commerce,26 and conditions contained in a state water quality certification. 27 After a license application is filed, it is processed by FERC and its staff principally in hearings conducted using notice and comment procedures, although trial-type hearings and alternative dispute resolution proceedings also may be employed. It is important to note, however, that the Commission s r e g u l a t i o n s c o n t a i ne x t e n s i v e , m a n d a t o r y , pre-application filing and consultation requirements. Prior to filing, an applicant must (i) consult with Federal and state resource agencies, affected land managing agencies, Indian tribes, and state water quality agencies; (ii) provide the entities consulted with information describing the proposed project; and (iii) conduct the studies necessary for FERC to subsequently make an informed decision on the application once it is filed.28 In July 2003, FERC adopted new regulations governing the filing and processing of license applications for original, new, and subsequentlicenses the so-called Integrated Licensing Process ( ILP ).29 Prior to July 23, 2005, the ILP was optional. It is now the default licensing process.30 F E R C s p r i n c i p a l p u r p o s e i n a d o p t i n g t h e I L Pw a s t o a d d r e s s t h e causes of the lengthy delays inherent in its traditional process and to make its licensing process more efficient and timely. The ILP places substantially more focus on the pre-filing stage of the licensing process by involving FERC staff, interested Federal and state agencies, and other potentially interested stakeholders well in advance of the actual filing of an application. FERC is hopeful that the ILP will reduce the time-frame for licensing to a period of approximately six to eight years. (Attached as Attachment A to this chapter is a
See FPA 18, 16 U.S.C. 811. EPAct 2005 amended FPA section 18 and added a new FPA section 33(b) which allows a license applicant (or other party) to propose an alternative to a fishway prescribed by either the Department of Interior or the Department of Commerce and requires the Secretary of the relevant Department to accept and prescribe the alternative if it is supported by substantial evidence and if it (a) will be no less protective than the fishway the Secretary prescribed, and (b) either will cost significantly less, or will result in improved electricity production. See EPAct 2005 241(b), 119 Stat. at 674-75 (amending 16 U.S.C. 811); id. 241(c) (adding 16 U.S.C. 823d(b)). License applicants are required to obtain such a certification (or waiver) under section 401(a)(1) of the Clean Water Act, 33 U.S.C. 1341(a)(1), and conditions in such a certification must be included by the Commission in the license under section 401(d), see id. 1341(d). The general rules governing applications for preliminary permits, licenses and exemptions are set forth in 18 C.F.R. Part 4, Subparts D-I. The content and other requirements vary depending on the type of application, size and other characteristics of a project. T h e I L Pc a n b e f o u n d a t 1 8 C . F . R . P a r t 5 . A n e wl i c e n s e i s a l i c e n s e t o b e i s s u e d u n d e r section 15(a) of the FPA after an original license expires, but does not include an annual license i s s u e du n d e r s e c t i o n1 5 ; a s u b s e q u e n t l i c e n s e i s al i c e n s et ob ei s s u e df o r am i n o r w a t e r p o w e r project after expiration of its existing term if the existing licensee presently is not subject to sections 14 and 15 of the FPA. See 18 C.F.R. 5.1(a)(2)-(3); see also id. 16.2(a), 16.2(d) (defining terms).
29 28 27 26
See 18 C.F.R. 5.1(f), 5.3. Note, however, that under the transition provisions of 5.31, the ILP governs applications for which the deadline for filing a notice of intent to seek a n e w o r s u b s e q u e n t l i c e n s e o c c u r s o n o r a f t e r J u l y 2 3 , 2 0 0 5 . A s d i s c u s s e d b e l o w , u n d e r 1 8 C . F . R . 5.5(d), an existing licensee must file such a notice not less than 5 years and not more than 5 years before its existing license expires.
30
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C o m m i s s i o ns c h e m a t i co f t h eI L Pp r o c e s s w h i c hs h o w s t h eC o m m i s s i o n s e s t i m a t e dt i m e line.) Existing licensees also need to pay particular attention to the time by which they are required to inform the Commission of their intent to file an application for a new license and the consequences that flow from making (or failing to make) such a filing.31 Under the ILP, an existing licensee must file a notice of intent with FERC (and others) not less than five or more than five and one-half years in advance of the expiration of the term of the existing license unequivocally stating whether or not it intends to file a new or subsequent license and, within 60 days thereafter, file a pre-application document. Failure to make a timely filing of a notice of intent has onerous consequences: the licensee will be deemed to have notified the Commission that it does not intend to file an application. If a timely notice informed the Commission of an intent not to file (or, if the notice is deemed as such), the existing licensee is prohibited from filing an application for a new license, a non-power license, or an exemption, either individually or in conjunction with an entity or entities that are not currently licensees of the project. If a timely notice of intent has been filed, the party must subsequently file its application at least twenty-four months before expiration of the term the existing license. A licensee that fails to meet the twenty-four month deadline is prohibited from filing an application for a new license, non-power license or exemption for the project, either individually or in conjunction with an entity or entities that are not currently licensees of the project. Further information prepared by FERC staff concerning the licensing process (including a Licensing Handbook and guidance on Environmental Analysis Preparation) is 32 a v a i l a b l e o n t h e C o m m i s s i o n s w e b s i t e . IV. FEES Under sections 10(e) and 10(f) of the FPA, licensees are required to pay three types of annual charges.33 These charges are: a. costs incurred by the United States in administering Part I of the FPA;34
The requirements are different for existing licensees to whom the ILP does not apply. See 18 C.F.R. 16.1-16.5.
32 33
31
These materials are available at http://www.ferc.gov/hydro.
See 16 U.S.C. 803(e)-(f); see also City of Tacoma v. FERC, 331 F.3d 106, 108 n.2 (D.C. Cir. 2003); City of Vanceburg v. FERC, 571 F.2d 630, 643 (D.C. Cir. 1977). See 18 C.F.R. 11.1; see also East Columbia Basin Irrigation Dist. v. FERC, 964 F.2d 1550, 1557-8 (D.C. Cir. 1991) (holding that FERC has exclusive authority under section 10(e) to assess annual charges).
34
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK b. reasonable annual charges for the use, occupancy and enjoyment of public land;35 and c. payment for the use of government dams.36
T h e t w om a i nc h a r g e s a r e t h o s e r e l a t i n gt ot h e C o m m i s s i o n s c o s t s a n dc e r t a i nc o s t s of other federal agencies ( OFA Charges ) incurred in connection with their administration of or participation in the licensing and regulation of projects under the FPA. For purposes of determining annual charges, the Commission requires each licensee to file, on or before November 1 of each year, a statement under oath showing the gross amount (in kilowatt hours) of power generated and the amount of power used for pumped storage pumping by the project during the preceding fiscal year.37 If a licensee fails to report t h e g r o s s e n e r g y o u t p u t o f i t s p r o j e c t b yN o v e m b e r 1 , t h e C o m m i s s i o n s s t a f f w i l l e s t i m a t e the energy output, and this estimate may be used in lieu of the filings made by the licensee after November 1. The Commission then provides a bill to the licensee, which lists the various annual fees. The costs its collects from individual licensees are pro-rated on the basis of the share of total generation output that a particular facility represents. The formulas used for each annual fee are set out in an assessment table accompanying the bill. The billing system is therefore based on a volume mechanism,w h e r ee v e r yh y d r o e l e c t r i cf a c i l i t y s output and charges are taken into consideration. Licensees must pay annual charges within forty-five days after a bill is issued. 38 Failure to pay within the allotted time period results in a penalty of five percent of the delinquent amount for the first late month, and then three percent for each month thereafter that the payment is delinquent.39 If a licensee believes that its bill for annual charges is incorrect, it may file an appeal within forty-five days after issuance of the bill. As a result of litigation regarding the reasonableness of the Commission s methodology in determining OFA Charges, beginning in fiscal year 2002, the Commission suspended its billing of OFA Charges with respect to all jurisdictional hydroelectric facilities pending completion of its response to any additional review requirements that may be imposed as a result of the litigation. 40 Licensees should bear this fact in mind when developing their budgets. At this time no specific standards exist for determining what amounts should be budgeted for OFA Charges for the years following 2001. The highest historical amount paid may provide a rough measure. Licensees needing further guidance on the potential impact of this litigation and in determining the scope of their potential related
35 36 37 38 39 40
18 C.F.R. 11.2. Id. 11.3. Id. 11.1(c)(4). Id. 11.20. Id. 11.21. See City of Idaho Falls, 107 FERC 61,277, at P 31 (2004).
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OFA Charges liability should work with Commission staff and consult counsel, as appropriate. V. SPECIFIC POTENTIAL COMPLIANCE ISSUES FERC administers its license compliance program largely through its regional offices located in Atlanta, New York, Chicago, Portland, and San Francisco. Establishing and maintaining a good working relationship with the regional engineer and staff of the office that oversees a project is important for a licensee. The regional offices provide valuable advice and assistance to licensees, particularly when problems arise, as they inevitably do. Each license issued by the Commission is a self-contained instrument, which authorizes the licensee to develop, construct, operate and maintain a project, and requires that such activities be carried out in accordance with the plan of development approved by FERC in the license, the special terms and conditions set out in the license, 41 a n dF E R C s 42 standardlicensing articles. In this regard, the license instrument itself provides the licensee with a road-map to the various items with which it must comply and which will require ongoing monitoring. 43 In addition, every license will describe with particularity (i) the licensee (the legal name of the entity or person to whom the license has been issued); (ii) the project (its general and specific features, including a legal description of its boundaries) s u b j e c t t o t h e t e r m s a n d c o n d i t i o n s o f t h e l i c e n s e a n d t h e C o m m i s s i o n s j u r i s d i c t i o n u n d e r t h e FPA; (iii) the installed (or authorized) capacity of the project; and (iv) the term of the license. Licensees should note that the increased complexity of the special terms and conditions of licenses lends itself to establishing a catalogue of compliance items, developing an internal plan for how long lead-time compliance items will be handled and a tickler program to track internal plan deadlines and FERC-imposed filing deadlines. Particular attention should be paid to tracking compliance with any conditions of the license that contain re-openertype clauses, since they pose the greatest risk of unknown future cost exposure during the term of the license.44 The terms of the standard articles (incorporated
For example, FERC typically imposes conditions affecting project operations, flow levels, fish and wildlife protection measures, recreation facilities, dam safety and aesthetics. Changes in environmental laws and emphasis as well as increased public awareness of potential environmental impacts have caused compliance with these conditions to become increasingly complex and costly. F E R C ss t a n d a r dl i c e n s ea r t i c l e sv a r yw i t ht h et y p eo fp r o j e c tu n d e rl i c e n s e( o r exemption) and are available on the FERC website at http://www.ferc.gov/industries/hydropower/ gen-info/l-forms.asp.
42
41
A s n o t e da b o v e , F E R C s D i v i s i o no f H y d r oP o w e r A d m i n i s t r a t i o na n dC o m p l i a n c e h a s published a detailed compliance handbook, which can be found at http://www.ferc.gov/industries/ hydropower/enviro/compliance_handbook.pdf. In addition, each new licensee will receive a letter from FERC staff outlining the basic compliance issues of which it should be aware.
43
Under section 6 of the FPA, after a license is issued it may only be altered on such terms as may be agreed to by the Commission and the licensee. 16 U.S.C. 799. In this regard, a licensee is afforded a certain measure of protection and certainty against unknown risks once its license is issued. However, licenses may be issued with conditions in which FERC (or another agency)
44
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by reference into each license) require licensees to own (or acquire) all property rights necessary for the construction, operation and maintenance of the licensed project. Acquisition of those rights is mandatory and can be accomplished by agreement or, if necessary, by the exercise of the federal power of eminent domain under section 21 of the FPA. Careful attention should be paid to how the boundaries of the project are described in a license application, excluding to the extent possible those real or personal property interests that are not necessary for construction, operation or maintenance of the project. A number of post-licensing events can trigger the need for a licensee to notify the Commission or to seek further authorization and approval. Events of this type include transfers, sales or other dispositions. Any transaction by a licensee that involves a voluntary transfer of license, or a voluntary sale or other disposition (e.g., a judicial sale or an assignment) of any of the proprietary rights necessary to the operation or maintenance of a project, requires prior FERC authorization and approval under section 8 of the FPA.45 A sale or other disposition of an entire project requires prior approval of the transfer of the license to the person or entity acquiring the project.46 A sale or other disposition that involves a new ownership arrangement for the project between an existing licensee and a third party (e.g., a new joint owner, or a lessor in sale-leaseback transaction) requires prior approval of the transfer of rights under license to the new owner and an amendment of the license to add the joint owner as a co-licensee. Sale-leaseback transactions can raise special difficulties. The passive owner lessors are required to be named licensees because they will hold legal title to project works and property, even though they normally will not be involved with operation and maintenance of the project on a day-to-day basis.47 Particular attention should be paid to involving them in any transfer in order to ensure that prior approval of a transfer of their interests is obtained. Involuntary transfers (mortgage, trust deed or judicial sales) of a license are specifically excluded from the prior approval requirement of section 8 of the FPA insofar as the existing licensee is concerned. Before any person or entity can lawfully exercise the rights acquired through an involuntary transfer, however, it will have to seek prior authorization and approval from the Commission to have the license transferred to it.
r e s e r v e s t h e r i g h t t oa d dt oo r c h a n g e t h e c o n d i t i o n s ( e.g., a condition in which the Department of I n t e r i o r r e s e r v e s t h e r i g h t t o a l t e r o r p r e s c r i b e f i s h w a y s a s i t m a y d e e mn e c e s s a r y i n t h e future). 16 U.S.C. 801. The standard license articles permit a very limited number of d i s p o s i t i o n s b y a l i c e n s e e w i t h o u t p r i o r a p p r o v a l .F o r e x a m p l e , A r t i c l e 5o f t h e C o m m i s s i o n s F o r m L-1, Terms and Conditions of License for Constructed Major Project Affecting Lands of the United States, provides that the abandonment or the retirement from service of structures, equipment, or other project works in connection with replacements thereof when they become obsolete, inadequate, or inefficient for further service due to wear and tear; and mortgage or trust deeds or judicial sales made thereunder, or tax sales, are not deemed to be voluntary transfers. See 18 C.F.R. Part 9. Note that the new licensee must demonstrate that it is qualified to fulfill the terms and conditions of the license and to operate the project in the same manner as is required for license applicants. See Allegheny Hydro No. 8 L.P., 55 FERC 61, 446 (1990); see also Boott Hydropower, Inc., 111 FERC 62, 001 (2005).
47 46 45
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Licensees are required to notify the Commis s i o no f c h a n g e si nt h el i c e n s e e sl e g a l name. The notice may be provided in the form of a letter to the Commission and should be provided promptly after the change occurs. 48 Where upstream ownership of a licensee changes hands (e.g., another entity acquires 100% of the stock of a licensee) but the legal name of the licensee remains the same, there is no requirement, under Part I of the FPA, to provide notice to the Commission or to seek approval of the transfer under section 8 of the FPA (though other statutory requirements may be triggered, such as a requirement for prior authorization under section 203 of the FPA (see Chapter 5)). Finally, any changes in the physical features or boundaries of a licensed project, or any other changes to the project that are of such a character so as to constitute an alteration of the licenserequire a licensee to obtain Commission approval by the filing of an application for amendment of license.49 Any changes to the installed capacity of a project or the boundaries of a project will trigger consultation requirements that will have to be satisfied in advance of filing.
48 49
See North Hartland, LLC 109 FERC 61,194 (2004). See 18 C.F.R. 4.200.
Attachment A
Integrated Licensing Process Final Rule
5.5-5 yrs<exp
Applicant files NOI and Pre-Application Document (PAD) Initial Tribal Consultation Mtg. Applicant may request use of TLP or ALP
60
Commission notices NOI/PAD and issues Scoping Document 1 (SD1) Commission acts on TLP or ALP requests 3 5.8 Commission holds Scoping Meetings/ Site Visit Discuss issues, mgmt obj, existing info, info needs, process plan, and schedule 4 5.8 5.9
30
30
Comments on PAD, SD1 and Study Requests
45
Applicant Files Proposed Study Plan 5.11
90
30 30 30
Commission issues Study Plan Determination 11a Mandatory conditioning agencies file notice of study disputes 11b 5.14 5.14 Study Dispute Resolution Process 12 No disputes Comments on use of TLP or ALP, if requested 5.3 2b
5.7
2a
Commission issues SD2, if necessary 5 5.10
Study Plan Meeting(s) (informal resolution of study issues)
Comments on Proposed Study Plan
5.3, 5.5, 5.6 1
30
5.11
5.12
Pre-Application Activity
30
Applicant files revised Study Plan for Commission approval Agencies may file reply comments within 15 days 9 5.13 5.13 10
20
20
70
5.14
Determination on Study Dispute 13
First season studies and Study Review: 1) Applicant files initial study report 2) Study meeting 3) Requests for study plan modification 14 5.15
Second season studies, if needed, and Study Review (same as first season)
5.15
15
Applicant's Preliminary Licensing Proposal (not later than 150 days before application) Additional Information Requests, if needed 5.16 17 5.16 16
90
Comments on Applicant's Preliminary Licensing Proposal
2 yrs<exp
License Application 5.19
14
Tendering Notice 19a
60
Notice of Acceptance Notice of Ready for Environmental Analysis
60
Comments, Interventions, preliminary terms and conditions Reply comments in 45 days 21 5.22 20 5.23
120
Commission issues non-draft EA 5.24 22a Commission issues Draft EA or EIS
30-45
Comments on EA 5.24
60
Modified terms and conditions
23a
5.24
24a
Post-Filing Activity
5.17, 5.18
18
30 5.19
Commission decision on any outstanding prefiling AIR 19b
Comments on Draft EA or EIS
Modified terms and conditions
180
5.25
22b
30-60
5.25
23b
60
5.25
24b
Commission issues license order
Commission issues Final EA or EIS
90
5.25
25
26
Chapter 14 The Regulation of Qualifying Facilities Under PURPA

DONNA M. FRANCESCANI LILY GIRMA INTRODUCTION I nt h i sc h a p t e r , w ed i s c u s sr e g u l a t i o n sg o v e r n i n g q u a l i f y i n gf a c i l i t i e s o r Q F s , 1 pursuant to the Public Utility Regulatory Policies Act of 1978, as amended ( P U R P A ) . Throughout the chapter, we offer specific insights and recommendations on compliance with t h eF e d e r a l E n e r g yR e g u l a t o r yC o m m i s s i o n s ( FERCo r C o m m i s s i o n ) QF regulations and discuss the attendant risks for failure to do so. We also identify some of the significant c h a n g e si nt h el a wg o v e r n i n gQ F s a s ar e s u l t o f t h eE n e r g yP o l i c yA c t o f 2 0 0 5( E P A c t 2 2005 ) and highlight some questions and issues related to QFs that are likely to be debated and decided by FERC in coming months and years as a result of the EPAct 2005 amendments to PURPA:3 First, we briefly describe the nature and purpose of PURPA and the QF regulations promulgated by FERC pursuant to PURPA. Second, we discuss the regulations governing the process of certifying a facility as a QF a sw e l l a st h ep r o c e d u r e sb yw h i c haf a c i l i t y sQ Fs t a t u sm a yb e challenged and potentially revoked. Third, we address the substantive requirements for qualifying cogeneration and qualifying small power production facilities, respectively.
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Ms. Francescani has represented clients in FERC litigation, as well as in state and federal court proceedings and domestic and international arbitration proceedings. Ms. Francescani has represented QF developers and owners, and lenders to QF projects, in a variety of different contexts including complex contract disputes and challenges to projects' QF status.
1 2 3
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. 16 U.S.C. 2601 et seq. (2004). Pub. L. No. 109-58, 119 Stat. 594 (2005).
In this r e g a r d , w e a d d r e s s an u m b e r o f F E R C s o b s e r v a t i o n s a n dc o m m e n t s i nar e c e n t n o t i c eo f p r o p o s e dr u l e m a k i n gr e g a r d i n gi m p l e m e n t a t i o no f E P A c t 2 0 0 5 s c o g e n e r a t i o na n ds m a l l power production provisions. See Revised Regulations Governing Small Power Production and Cogeneration Facilities, N o t i c e o f P r o p o s e d R u l e m a k i n g , 1 1 3 F E R C 6 1 , 0 2 0 ( 2 0 0 5 ) ( O c t o b e r 2 0 0 5 N O P R ) .
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Fourth, we describe certain risks a company might face if a project it owns loses its QF status. I. NATURE AND PURPOSE OF F E R C S QF RULES
Congress enacted PURPA in an effort to combat the energy crisis facing the nation in the 1970s.4 Title II and in particular, section 210 of PURPA was intended to encourage t h e d e v e l o p m e n t o f c o g e n e r a t i o na n ds m a l l p o w e r p r o d u c t i o nf a c i l i t i e s , a n dt h u s t or e d u c e 5 A m e r i c a nd e p e n d e n c eo nf o s s i lf u e l sb yp r o m o t i n gi n c r e a s e de n e r g ye f f i c i e n c y . To accomplish these goals, section 210 directed FERC, in consultation with state regulatory a u t h o r i t i e s , t op r o m u l g a t e s u c hr u l e s a s i t d e t e r m i n e s n e c e s s a r yt oe n c o u r a g e c o g e n e r a t i o n 6 a n ds m a l l p o w e r p r o d u c t i o n , including rules requiring utilities to offer to sell electricity to and purchase electricity from, non-u t i l i t y q u a l i f y i n g c o g e n e r a t i o no rs m a l lp o w e r production facilities.7 In turn, PURPA required state regulatory authorities to implement 8 F E R C s r u l e s . As discussed below, the key initiatives for promoting the development of QFs under PURPA, as implemented by FERC (i.e., the key incentives for project developers and investors to build QF projects), included: (1) the requirement that public utilities i n t e r c o n n e c t w i t h a n d p u r c h a s e t h e e l e c t r i c o u t p u t o f Q F s a t t h e u t i l i t y s a v o i d e d c o s t ; a n d 9 (2) various exemptions from regulation under certain federal and state laws. The incentives provided by PURPA resulted in the development of many QF projects, particularly during the late 1980s and early 1990s. During this period, state regulators implementing PURPA often required public utilities to enter into long-term (typically 15 to 3 0y e a r ) p o w e r p u r c h a s e a g r e e m e n t s w i t hQ F s a t p u r c h a s e r a t e s b a s e do nt h e u t i l i t y s l o n g t e r ma v o i d e dc o s t s .A c c o r d i n g t oF E R Cr e g u l a t i o n , [ a ] v o i d ed costs means the incremental costs to an electric utility of electric energy or capacity or both which, but for the purchase from the qualifying facility or qualifying facilities, such utility would generate itself or 10 p u r c h a s e f r o ma n o t h e r s o u r c e . By requiring utilities to purchase QF electricity at what it
4 5
See FERC v. Mississippi, 456 U.S. 742, 745 (1982).
I n d e p e n d e n t E n e r g y P r o d u c e r s A s s n v . C a l i f o r n i a P u b . U t i l s . C o m m n , 36 F.3d 848, 850 (9th Cir. 1994).

6 7 8 9 10
16 U.S.C. 824a-3(a). See 18 C.F.R. 292.303 (2005); 16 U.S.C. 796(17) (18). See 16 U.S.C. 824a-3(f); see also note 6, supra. See 16 U.S.C. 824a-3(b) (e); 18 C.F.R. 292.303, 292.304, 292.601, 292.602.
18 C.F.R. 292.101(b)(6); see also Small Power Production and Cogeneration Facilities; Regulations Implementing Section 210 of the Public Utility Regulatory Policies Act of 1978, Order No. 69, 45 Fed. Reg. 12,214 (Feb. 25, 1980), FERC Stats. and Regs., Regs. Preambles 1997-1 9 8 1 3 0 , 1 2 8 ,a t3 0 , 8 6 5( 1 9 8 0 )( T h i sd e f i n i t i o ni sd e r i v e df r o mt h ec o n c e p to f t h e i n c r e m e n t a l c o s t t ot h ee l e c t r i cu t i l i t yo f a l t e r n a t i v ee l e c t r i ce n e r g y s e t f o r t hi ns e c t i o n2 1 0 ( d ) o f P U R P A . ) .
QUALIFYING FACILITIES
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c a l l e da f u l l a v o i d e dc o s t r a t e , F E R Cw a s s e e k i n gt op r o v i d e t h em a x i m u mi n c e n t i v ef o r 11 the development of cogeneration and small power production. The avoided cost rates under these long-term agreements have proved, over time, to be favorable in many cases to QFs (as compared to prevailing market rates). The agreements (as well as certain other key project financing agreements) routinely contain provisions that require a project to maintain its QF status. The breach or failure to maintain QF status typically gives a public utility purchaser the right to terminate the power sales agreement and, in turn, may cause the QF to be in default under its financing agreements. Thus, c o m p l i a n c ew i t hF E R C s Q Fr e g u l a t i o n s i s u s u a l l yc r i t i c a l t op r e s e r v i n gaQ F s e c o n o m i c value. As discussed below in section IV, even in the absence of a long-term agreement, loss of QF status can have other significant consequences. II. LEGAL REQUIREMENTS APPLICABLE TO QFS
A. THE PROCESS FOR OBTAINING QF STATUS Under FERC regulations, there are two ways to certify QF status: (1) by filing a notice of self-certification; or (2) by applying to FERC for a certification order. Both routes have been equally valid in the past for purposes of certifying either a small power production facility or a cogeneration facility. It should be noted, however, that FERC solicited comments in the October, 2005 NOPR as to whether new cogeneration facilities should continue to be permitted to self-certify in the future, given the EPAct 2005 amendments to the requirements for qualifying cogeneration facilities (discussed in section III.A, below). Once the basic features of a project are determined including (depending on whether the facility is a cogenerator or a small power production facility) identification of the project site, the technology to be employed, the primary fuel source, and the facility size a QF project owner or developer can file for QF status at any time. Certification is typically required as a contractual matter and as a legal matter prior to the initiation of commercial operations. We recommend making the QF filing with FERC within a year of the anticipated date of facility operations. 1. Self-Certification P u r s u a n t t o F E R Cr e g u l a t i o n s , t h e o w n e r o r o p e r a t o r o f a f a c i l i t y c a n s e l f -c e r t i f y a s a QF by preparing and filing a notice of self-c e r t i f i c a t i o nc o n t a i n i n gac o m p l e t e d F o r m 12 5 5 6 , and demonstrating compliance with the controlling FERC regulations, which are discussed in more detail in section III. A party self-certifying a facility as a QF must also serve this information upon each utility with which it expects to interconnect, transmit or sell
11
See generally American Paper Inst., Inc. v. American Elec. Power Serv. Corp., 461 U.S.
402 (1983). 1 8C . F . R . 2 9 2 . 2 0 7 ( a ) ( 1 ) ( i i ) .C o p i e s o f F o r m5 5 6a r e a v a i l a b l e o nF E R C s w e b s i t e a t www.ferc.gov/docs-filing/hard-fil.asp. As a result of changes in law brought about by EPAct 2005, FERC is in the process of revising Form 556. See October 2005 NOPR, 113 FERC 61,020 at PP 34-35.
12
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energy, and with the appropriate state regulatory authorities.13 Under the self-certification method, FERC does not issue a certification order or otherwise act on the filing, unless it is challenged. One advantage to the self-certification method is that there is usually no need to await action from FERC before certification is effective. One disadvantage to the selfcertification method is that it provides less regulatory certainty than a FERC certification order because, at least initially, representations in a self-certification filing may go untested. Thus, the self-c e r t i f i c a t i o n m e t h o d i s t y p i c a l l y u s e d f o r g a r d e n v a r i e t y Q F s t h a t clearly fall w i t h i nF E R C s existing regulations and past QF orders, and do n o t p r e s e n t n o v e l o r c l o s e c a l l f a c t p a t t e r n s . 2. Application for FERC Certification The second option for obtaining certification is to file an application requesting that FERC issue an order certifying a facility as a QF. 14 As with the self-certification method, an applicant is required to submit a completed Form 556.15 The application is subject to formal notice in the Federal Register and the applicant is required to pay a filing fee.16 It is not uncommon for FERC to request additional information before acting on a QF certification application. However, if FERC does not respond to a completed application within 90 days, it is deemed to have been granted.17 The pros and cons of applying for certification are the reverse of those for selfcertification: a formal application takes more time and costs more money, but it brings certainty as long as the facts stated in the application are accurate and complete. Thus, an application for certification often is made (1) when there are novel facts or the application of controlling law to the facts is uncertain; and/or (2) when a financial institution is involved in financing the project since financial institutions typically have a low risk tolerance, even given relatively routine circumstances. B. RECERTIFICATION AND REVOCATION OF QF STATUS A party may only rely upon a self-certification or FERC certification order to the extent that the material facts in QF filings remain true and accurate.18 To the extent that
13 14 15 16
18 C.F.R. 292.207(a)(1)(ii). Id. 292.207(b). Id. 292.207(b)(2).
See id. 381.505. The applicable fee differs depending on whether the application relates to a small power production facility or a cogeneration facility.
17 18
Id. 292.207(b)(3). Id. 292.207(d)(1)(i).
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those facts change, a party must either self-recertify or seek FERC recertification if it wishes to continue to rely on its certification. 19 If a QF falls out of compliance with the controlling QF regulations, FERC can revoke its QF certification. 20 A n y p e r s o n m a y i n i t i a t e a c h a l l e n g e t o a f a c i l i t y s c o m p l i a n c e w i t h t h e regulatory requirements for QFs.21 The implications of revocation of QF status are discussed in section IV, below. C. COMPLIANCE RECOMMENDATIONS As stated above, the validity of a QF certification whether it be a self-certification or a certification order rests on the underlying factual representations, which remain critically important even after a filing is made. The regulations state, and FERC has confirmed, that as long as a facility meets the controlling QF requirements, it may qualify as a QF even if it has not been properly certified.22 Nevertheless, if facts are materially misstated in any QF filing, or change materially thereafter, the validity of a QF certification is at risk.23 FERC has heightened its scrutiny of existing and newly filed notices of QF selfcertification since its investigation into certain Enron-affiliated QFs in 2002. During that investigation, FERC stated that it was reviewing its QF files to determine whether other facilities failed to meet the controlling criteria for QF status.24 Prior to the Enron investigation, FERC did not routinely investigate self-certified QFs. That practice has changed. Any new applications or notices of self-certification should be prepared with these concerns in mind, and owners or operators of facilities should provide detailed descriptions of how a particular facility meets the controlling QF requirements. Moreover, when material facts presented to FERC in a QF filing change, those changed facts should be reported to F E R Cs o t h a t t h e f a c i l i t y s Q F c e r t i f i c a t i o n w ill continue to be effective.
I na d d i t i o n ,t h er e g u l a t i o n sp r o v i d ef o ral e s sf o r m a l , p r e -authorized Commission r e c e r t i f i c a t i o n , w i t hr e s p e c t t oc e r t a i nt y p e so f changes of facts. See 18 C.F.R. 292.207(a)(2) (listing these preauthorized changes).
19 20 21 22
Id. 292.207(d)(ii)-(iii). Id.
Id. 292.207(a); see also Mesquite Lake Assocs., Ltd., 63 FERC 61,351, at 63,233 ( 1 9 9 3 ) ( [ A ] c h a n g e i n f a c t s f r o mt h o s e p r esented in a notice of self-certification or an application for Commission certification does not necessarily mean that the facility no longer is a QF. That question ultimately turns on whether the facility continues to satisfy the ownership and technical requirements f o r q u a l i f y i n g s t a t u s f o u n di n t h e s t a t u t e a n d t h e C o m m i s s i o n s r e g u l a t i o n s . . . . ) ( e m p h a s i s a d d e d ) (footnote omitted). Maintaining a valid QF certification may be required as a contractual matter, separate and apart from maintaining a project's QF status. For instance, such a requirement might be found in a power sales agreement or in a financing agreement. Investigation of Certain Enron-Affiliated QFs, 103 FERC 61,122, at 61,388 (2003) ( d i s c u s s i n g r e v i e wo f Q Ff i l e s t o d e t e r m i n e compliance).
24 23
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK III. LEGAL REQUIREMENTS FOR QF STATUS
A QF can be either a qualifying cogeneration facility, a qualifying small power production facility or, i nc e r t a i nc a s e s , b o t h .F E R C sQ Fr e g u l a t i o n ss e t f o r t hs p e c i f i c criteria for qualifying cogenerators and qualifying small power producers. The criteria for each are different, and are discussed below in subsections III.A and III.B, respectively. 25 A. CRITERIA FOR QUALIFYING COGENERATION FACILITIES 1. The Operating and Efficiency Requirements A cogeneration facility is one that produces electric energy and another form of useful thermal energy (such as heat or steam) for industrial, commercial, heating or cooling purposes.26 To be certified as a qualifying cogeneration facility, a facility must also meet operating and efficiency standards dictated by FERC regulations.27 In EPAct 2005, Congress directed FERC to revise its criteria for qualifying cogeneration facilities and implement heightened standards for operating and efficiency.28 In the October 2005 NOPR, FERC solicited comments on its proposed approach for carrying out this directive. F E R C s r e g u l a t i o no nthe criteria for qualifying cogeneration facilities is 18 C.F.R. 292.205, w h i c hc o n t a i n s a n o p e r a t i n gs t a n d a r d a n da n e f f i c i e n c ys t a n d a r d . P r i o r t o enactment of the amendments directed in EPAct 2005, the operating standard required that t h e u s e f u l t h e r m a l e n e r g y o u t p u t o f a f a c i l i t yb e n ol e s s t h a n 5p e r c e n t o f t h e t o t a l e n e r g y output on average during any calendar year of operation.29 In determining whether thermal e n e r g y q u a l i f i e d a s u s e f u l , F E R Ca p p l i e d a n e s s e n t i a l l y i r r e b u t t a b l e p r e s u m p t i v e l y u s e f u l standard:30 [i]f the use of a cogeneration facility's thermal output constitutes a common industrial or commercial application, it is presumptively useful and the Commission 31 performs no further analysis of thermal use. Pursuant to EPAct 2005, Congress has directed FERC to adopt criteria to ensure that the electrical, thermal and chemical output of
Prior to the passage of EPAct 2005, QFs were subject to an ownership limitation, p u r s u a n t t o w h i c h m o r e t h a n 5 0 p e r c e n t o f t h e e q u i t y i n t e r e s t i n [ a ] f a c i l i t y c o u l d n o t b e h e l d b y a n electric utility or utilities, or by an electric utili t yh o l d i n g c o m p a n y . 1 8C . F . R . 292.206(b). With the passage of EPAct 2005, however, the ownership limitation has been eliminated. EPAct 2005 1253(b). Although FERC has yet to revise its regulations to reflect this change, it proposed amendments to do so in the October 2005 NOPR. See October 2005 NOPR, 113 FERC 61,020 at P 32-33; see also Woodland Biomass Power, Ltd., 113 FERC 61,090 (2005) (granting waiver of ownership regulation in view of EPAct 2005, and granting authority to Director of Office of Markets, Tariffs and Rates to grant similar uncontested waiver requests).
26 27 28 29 30 31 25
16 U.S.C. 796(18)(A). Id. 796(18)(B); 18 C.F.R. 292.205. EPAct 2005 1253(a). 18 C.F.R. 292.205(a)(1). See, e.g., Brooklyn Navy Yard Cogeneration Partners, L.P., 74 FERC 61,015 (1996).
October 2005 NOPR, 113 FERC 61,020 at P 7 (citing Brooklyn Navy Yard, 74 FERC 61,015) (emphasis added).
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new cogeneration facilities is u s e d fundamentally for industrial, commercial or institutional p u r p o s e sa n di sn o t i n t e n d e df u n d a m e n t a l l yf o rs a l et oa ne l e c t r i cu t i l i t y , a n dt h a t t h e 32 t h e r m a l o u t p u t o f s u c h f a c i l i t i e s i s u s e d i n a productive and beneficial m a n n e r . In the October 2 0 0 5N O P R , F E R Cd e s c r i b e dt h e f u n d a m e n t a l u s e s t a n d a r da sa r e s p o n s e t o P U R P Am a c h i n e s , d e s i g n e d p r i m a r i l y t o s e l l e l e c t r i c i t y t o a u t i l i t y , a s o p p o s e d t ot r u e c o g e n e r a t i o n f a c i l i t i e s , i n t e n d e d t o s e r v e t h e t h e r m a l , e l e c t r i c a l o r o t h e r n e e d s o f t h e 33 co g e n e r a t i o nf a c i l i t y sh o s t . FERC sought comments on whether to implement the f u n d a m e n t a lu s e s t a n d a r d( 1 )t h r o u g ha d o p t i o no fa r e q u i r e dp e r c e n t a g eo fo u t p u t dedicated to industrial, commercial or institutional use (as opposed to sale to a utility), or (2) through a case-by-case approach. Wi t h r e s p e c t t o t h e p r o d u c t i v e a n db e n e f i c i a l u s e s t a n d a r d , F E R Ce x p l a i n e di nt h e October 2005 NOPR that it would abandon the irrebuttable presumption of usefulness and would instead scrutinize representations regarding the usefulness of thermal output to ensure their accuracy.34 F E R C s e f f i c i e n c yc r i t e r i as e t s f o r t ht h r e s h o l d sf o r t h ep e r c e n t a g eo f u s e f u l p o w e r and thermal output, in relation to the energy input. To date, the efficiency criteria has applied only to oil and natural gas fired QFs.35 However, FERC has proposed applying the efficiency criteria to coal fired QFs under its revised rules. 36 Furthermore, as a result of EPAct 2005, FERC will add certain new efficiency criteria for qualifying cogenerators in o r d e rt o e n s u r ec o n t i n u i n gp r o g r e s si nt h ed e v e l o p m e n to fe f f i c i e n te l e c t r i c a le n e r g y 37 g e n e r a t i n g t e c h n o l o g y . 2. Compliance Recommendations As a general matter, cogeneration facilities tend to present a greater challenge from a compliance perspective than do small power production facilities.38 This is because the operating and efficiency requirements need to be closely monitored and because certain issues, such as t h es t a t u s o f t h et h e r m a l h o s t , m a yb eo u t o f aQ Fo w n e r s c o n t r o l .F o r instance, if a host goes bankrupt, or fails to take sufficient thermal energy to meet operating and efficiency requirements, it can cause problems for the QF.
32
EPAct 2005 1253(a), 119 Stat. at 969 (adding 16 U.S.C. 824a-3(n)) (emphasis October 2005 NOPR, 113 FERC 61,020 at PP 10-13. Id. at PP 7-9. 18 C.F.R. 292.205(2). October 2005 NOPR, 113 FERC 61,020 at P 15. Id. at P 17.
added).
33 34 35 36 37 38
FERC has, however, waived its operating and efficiency requirements. See, e.g., Decatur Energy Center, LLC, 110 FERC 61,045 (2005) (discussing factors considered in determining waiver request and citing numerous orders on waiver).
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In the post-EPAct 2005 world, careful monitoring of the operating and efficiency requirements will continue to be key. In addition, owners of cogeneration facilities applying for QF status should be mindful of the heightened scrutiny they will receive, particularly with respect to proposed use of thermal output. B. SMALL POWER PRODUCTION FACILITIES A small power produ c t i o n f a c i l i t y i s a f a c i l i t y w h i c h i s a n e l i g i b l e s o l a r , w i n d , w a s t e or geothermal facility, or a facility which (i) produces electric energy solely by the use, as a primary energy source, of biomass, waste, renewable resources, geothermal resources, or any combination thereof; and (ii) has a power production capacity which, together with any other facilities located at the same site (as determined by the Commission), is not greater than 80 39 m e g a w a t t s . To be certified as a qualifying small power production facility, a facility must also meet both the size and fuel use standards dictated by the FERC regulations. 40 1. Size and fuel input There is no size limitation on an eligible solar, wind waste or geothermal facility, as defined by section 3(17)(E) of the F e d e r a l P o w e r A c t ( FPA ) .41 Non-eligible facilities generally cannot exceed 80 MW at the same site.42 Facilities are considered located at the same site if they are within one mile of one another.43 FERC can waive the one-mile rule, but economic constraints or difficulties generally have not been found to be grounds for waiver.44 Finally, small power producers must employ primarily alternative fuel or waste inputs.45 Oil, natural gas and coal may be utilized, but only for limited purposes.46 2. Compliance Recommendations The key compliance considerations for qualifying small power production facilities are size limitation and fuel input. Facility owners or operators should be particularly mindful o f m o n i t o r i n ga Q F s u s e o f o i l , n a t u r a l g a s a n dc o a l t ob e sure that use of such traditional fossil fuels is limited to approved purposes, pursuant to the FPA. The D.C. Circuit has
16 U.S.C. 796(17)(A). There is a limited exception that permits "eligible" solar, wind, waste, and geothermal small power production facilities constructed and certified during a nowclosed window in time to exceed the 80 MW limit and still qualify as a QF. See Solar, Wind, Waste and Geothermal Power Production Incentives Act of 1990, Amendment, Pub. L. No. 102-46, 105 Stat. 249 (1991); 16 U.S.C. 796(17)(E).
40 41 42 43 44 39
Id.; 18 C.F.R. 292.204. 16 U.S.C. 796(17)(E). 18 C.F.R. 292.204(a). Id. 292.204(a)(2).
Vulcan/BN Geothermal Power Co., 52 FERC 61,095, at 61,476 (1990) (discussing precedent that economic savings alone will not support waiver).
45 46
18 C.F.R. 292.204(b). Id.
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strictly construed these limited approved fuel uses, and rejected a more expansive interpretation FERC had relied on for many years.47 Absent extraordinary circumstances, FERC will not waive the fuel use requirement, even for a limited period.48 IV. PENALTIES FOR NON-COMPLIANCE Generally speaking, loss of QF status means loss of significant benefits. In the postEPAct 2005 world, however, the future availability of certain of those benefits may be in q u e s t i o n .B e l o w , w es u m m a r i z es o m eo f t h eb e n e f i t s t h a t m i g h t b el o s t i f af a c i l i t y s Q F status is revoked and we highlight the significant changes brought about by EPAct 2005 with respect to the future availability of some of those benefits: A. DEFAULTS REFUNDS
UNDER
LONG-TERM CONTRACTS, LOSS
OF
AVOIDED COST SALES PRICING &
As discussed above, under section 210 of PURPA, QFs could force utilities to p u r c h a s e e n e r g ya n dc a p a c i t ya t t h e u t i l i t y s f u l l a v o i d e dc o s t r a t e , m e a n i n gt h e c o s t t h a t the utility itself would have to expend to generate or purchase power itself. Because many state regulators set long-term avoided cost rates at a level which turned out to be above actual market prices,49 many of these long-term contracts have proved to be very costly for utilities. Given that loss of QF status (or certification of QF status) is typically an event of default under a long-term power sales agreement, such a loss could jeopardize the favorable lockedin pricing structure contained in such an agreement.50 In other words, a QF may be able to continue selling power to the same utility after a default, but it may no longer be guaranteed the same lucrative price for its power. In addition, because loss of QF status can also trigger defaults under other agreements, it is crucial to have an understanding of the terms in all relevant agreements with respect to default and termination as a result of loss of QF status. In addition, pursuant to its mandate to ensure that rates for wholesale electricity sold in interstate commerce are just and reasonable, FERC also has authority to order refunds for
47 48
See Southern Cal. Edison Co. v. FERC, 195 F.3d 17 (D.C. Cir. 1999).
Cf. Daggett Leasing Corp., 64 FERC 61,148, o r d e r d e n y i n gr e h g , 65 FERC 61,143 (1993) (granting limited waiver where "once-in-a life-time" volcanic eruption threatened severe financial hardship for applicant in absence of waiver) and O'Brien Envtl. Energy, Inc., 65 FERC 61,038 (1993) (denying request for limited waiver of fuel use limitation). The change in competitive wholesale markets over the last dozen years has produced a profound change in the thinking of state regulators, and long-term contracts under state-established long-r u n a v o i d e dc o s t s a r e l a r g e l y a t h i n go f t h e p a s t .T o d a y s a v o i d e d c o s t r ates are more likely to be established through a competitive bidding procedure. See Administrative Determination of Full Avoided Costs, Order Terminating Proceeding, 84 FERC 61,265, at 62,300 (1998) (noting that competitive bidding is not only consistent with PURPA, but actually promises greater efficiency in setting avoided cost rates than a process of administrative determination). Interpretation of such contracts can be complicated, particularly if they contain provisions allowing the QF owners to attempt to cure non-compliance.
50 49
254
power sold during periods of noncompliance with QF regulations.51 A facility that is noncompliant for a given period of time may be ordered to refund the difference between its contractual avoided cost-based price and the actual incremental costs of the purchasing utility during the period of non-compliance. It should be noted that one of the changes wrought by EPAct 2005 that is likely to be significant but has yet to play out and be tested i s t h e e l i m i n a t i o n o f a u t i l i t y s o b l i g a t i o n to purchase QF power if FERC makes certain findings to the effect that the QF has nondiscriminatory access to a competitive wholesale market.52 While this change will not affect extant contracts, it will likely mean a new and different playing field for some old QFs when extant long-term contracts expire (or there is a default), and for some new QFs. B. LOSS OF EXEMPTIONS FROM STATE AND FEDERAL LAWS Traditionally, one of the most important benefits of becoming a QF has been exemption (at least for certain QFs) from regulation under Part II of the FPA, Public Utility H o l d i n gC o m p a n yA c t ( PUHCA ) , and most state regulations. Once again, however, EPAct 2005 a n dF E R C s O c t o b e r 2 0 0 5N O P Rc a s t d o u b t o nt h efuture status of some of these exemptions.53 Certain QFs are currently exempt from most sections of the FPA.54 This class of QFs is not subject to wholesale rate regulation by FERC under section 205 of the FPA and does not have to seek FERC approval for the sale or transfer of assets or issuance of securities under sections 203 and 204 of the FPA.55 C e r t a i nQ F s a r e a l s oe x e m p t f r o ms t a t e l a wo r regulation respecting (i) the rates of electric utilities; and (ii) the financial and organizational 56 regulation of electric utilities. T h i sm e a n st h e s eQ F sa r ee x e m p tf r o m u t i l i t y -t y p e regulation. If a facility loses its QF status, FERC could require the facility to file rate schedules as a public utility, which means that entity would have to justify its rates either on a cost or a market basis. Owners believing that their facility may no longer qualify as a QF at some
See, e.g., LG&E-Westmoreland Southampton, 76 FERC 61,116 (1996); reh'g denied and clarification granted, 83 FERC 61,182 (1998).
52 53 54
51
EPAct 2005 1253(a). See October 2005 NOPR at PP 19-31 (proposing elimination of certain exemptions).
18 C.F.R. 292.601(c)(1). QFs are not exempt from the licensing requirements under Part I of the FPA (sections 1-18, 21-30) or from sections 202(c), and 210-214 regarding (among other things) FERC authority over interconnection and wheeling. Id. A QF also is not exempt from FPA section 305(c), which requires any person holding the position of officer or director of a public utility a n do f a n o t h e r c o m p a n yi ns p e c i f i e dc a t e g o r i e s t of i l e w i t hF E R Cr e p o r t s o ns u c h i n t e r l o c k s . Id. This reporting requirement is discussed in Chapter 12 (Interlocking Directorates).
55 56
Id. 292.601(a), (b). Id. 292.602(c)(1).
255
point in the future have sometimes requested advance market based rate authority from FERC.57 CONCLUSION Obtaining QF status requires the provision of accurate and complete factual representations to FERC regarding all of the criteria required by Form 556. Maintaining the e f f e c t i v e n e s s o f a f a c i l i t y s Q Fcertification means ensuring not only that the facility adheres to the controlling regulations, but that the material facts presented to FERC in any QF filing remain true and accurate. It is essential, therefore, to keep detailed r e c o r d s o f af a c i l i t y s performance and (at least past) ownership structure. Monitoring such information and remaining watchful for changes in the material facts presented to FERC are the key compliance measures for owners and operators of a QF.
57
See, e.g., POSDEF Power Co., L.P., Letter Order, Docket ER04-947-000 (Sep. 16,
2004).
Chapter 15 Exempt Wholesale Generators

PAUL SILVERMAN I. SIGNIFICANCE OF EWG STATUS AND EWG PROCEDURES
E x e m p t w h o l e s a l eg e n e r a t o r s ( E WG s ) a r eac r e a t i o no f t h e E n e r g yP o l i c yA c t o f 1 1 9 9 2( E P A c t 1992 ) . That statute sought, among other things, to promote competition in bulk power markets. One of the most significant impediments to implementing such a policy 2 w a s t h eP u b l i c U t i l i t yH o l d i n gC o m p a n yA c t o f 1 9 3 5( P U H C A 1935 ) . Under PUHCA 1935, any company acquiring ten percent or more of the voting securities of a company that owns or operates facilities used to generate, transmit or distribute electric energy for sale, i.e., 3 a n e l e c t r i cu t i l i t yc o m p a n y , w o u l db eap u b l i cu t i l i t yh o l d i n gc o m p a n y . Unless that holding company was eligible for an exemption, it would be required to register with the S e c u r i t i e sa n dE x c h a n g eC o m m i s s i o n( S E C ) .R e g i s t r a t i o nw o u l ds u b j e c t t h eh o l d i n g company to substantial regulation, which Congress recognized could discourage investments in generation. Prior to EPAct 1992, developers of independent generation had two basic options if they wanted to avoid regulation under PUHCA 1935. First, they could develop facilities that m e t t h er e q u i r e m e n t sf o r aq u a l i f y i n gf a c i l i t y( Q F ) u n d e r t h eP u b l i cU t i l i t yR e g u l a t o r y 4 Policies Act of 1978 ( PURPA ). Second, if their facility could not satisfy QF requirements, they could hold it through a complex ownership structure, sometimes referred to as a P U H C Ap r e t z e l . I n E P A c t 1992, Congress eliminated the need to resort to PUHCA pretzels by amending PUHCA 1935 to include a new section, Section 32, which established EWGs as a new category of generating company.5 EWGs were not electric utility companies under PUHCA 1935,6 and therefore acquisitions of interests in EWGs did not cause the acquirer to become a holding company under PUHCA 1935.
1 2
Associate, Skadden, Arps, Slate, Meagher & Flom LLP. Pub. L. No. 102-486, 106 Stat. 2776 (1992).
Prior to its repeal by the Energy Policy Act of 2005, see infra note 7, PUHCA 1935 was codified at 15 U.S.C. 79a et seq. (2004).
3 4 5 6
15 U.S.C. 79b(a)(3) & (7) (repealed). For a discussion of QFs and PURPA, see Chapter 14. 15 U.S.C. 79z-5a(e) (repealed).
See, e.g., Indiantown Cogeneration, L.P., 112 FERC 62,239, at P 6 n.3 (2005); Black Hills Ontario, L.L.C., 106 FERC 61,152, at P 11 n.4 (2004).
258
The Energy Policy Act of 2005 ( EPAct 2005 ) repealed PUHCA 1935, effective 7 February 8, 2006. As a result, EWG status has lost much, but not all, of its significance. PUHCA 1935 has been replaced by a new statute entitled the Public Utility Holding C o m p a n yA c t o f 2 0 0 5( P U H C A2 0 0 5 ) .8 That statute, which will be administered by the F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n ( FERC o r t h e C o m m i s s i o n ) , preserves the basic concept of a public utility holding company and subjects holding companies to limited regulation by FERC. That regulation consists primarily of FERC access to holding company books and records relevant to rates it regulates, as well as regulation to prevent cross subsidization to the detriment of public utilities regulated by FERC under the Federal Power Act ( FPA ) and gas pipelines regulated under the Natural Gas Act ( N G A ) .9 PUHCA 2005 also gives state utility commissions access to holding company books and records relevant to the rates subject to their jurisdiction.10 PUHCA 2005 also preserves the concept of an EWG by incorporating the term EWGas used in Section 32 of PUHCA 1935. Specifically, it provides that the term exempt wholesale generator shall have the same meaning as in Section 32 as that provision existed on the day before the effective date of PUHCA 2005. 11 In addition, PUHCA 2005 provides that companies owning interests only in EWGs, QFs, and foreign utility companies 12 ( F U C O s ) will be exempt from the PUHCA 2005 provisions regarding FERC access to books and records.13 It is unclear at this time how burdensome regulation under PUHCA 2005 will be and thus how important EWG status is likely to be in the future. On September 16, 2005, FERC issued a notice of proposed rulemaking relating to the repeal of PUHCA 1935 and the implementation of PUHCA 2005.14 Among other things, FERC announced that it interpreted the provisions of PUHCA 2005 to provide that only those entities that are holding companies with respect to persons granted EWG status before the repeal of PUHCA 1935 will qualify for the exemption from the new federal books and
See EPAct 2005 1263, Pub. L. No. 109-58, 119 Stat. 594, 974 (2005) (repealing PUHCA 1935); id. 1274, 119 Stat. at 977 (setting effective date).
8 9 10 11 12 7
EPAct 2005 1261-1277, 119 Stat. at 972-78. Id. 1264, 1267. Id. 1265. Id. 1262(6).
Section 33 of PUHCA 1935 defined FUCOs as companies that own and/or operate facilities outside the United States that are used to generate, transmit or distribute electricity, or distribute natural gas at retail, and that do not otherwise operate in the United States. 15 U.S.C. 79z-5 b ( a ) ( 3 ) ( r e p e a l e d ) . L i k e E WG s , t h e o w n e r s h i p o f F U C O s d i d n o t c r e a t e a h o l d i n g c o m p a n y w i t h i n t h e m e a n i n g o f P U H C A1 9 3 5 .E P A c t 2 0 0 5 s t a t e s t h a t t h e t e r m f o r e i g n u t i l i t y c o m p a n y h a s the same meaning as in section 33 of PUHCA 1935 on the day before the effective date of PUHCA 2005. EPAct 2005 1262(6).
13 14
Id. 1266(a).
Repeal of the Public Utility Holding Company Act of 1935 and Enactment of the Public Utility Holding Company Act of 2005, Notice of Proposed Rulemaking, 112 FERC 61,300 (2005) ( P U H C AN O P R ) .
EXEMPT WHOLESALE GENERATORS
259
records access requirements.15 Accordingly, FERC proposed to eliminate its current EWG regulations and cease making determinations of EWG status following the effective date of PUHCA 1935 repeal. 16 FERC argued: We note that the benefit of exempt wholesale generator status under PUHCA 1935 was that entities that the Commission determined to have met the definition of exempt wholesale generator were exempted from the myriad requirements of PUHCA 1935. The principal benefit of being an exempt wholesale generator under PUHCA 2005 is the exemption from the new federal books and records access requirements. To the extent that these new federal books and records access requirements add to the Commission s existing very broad books and records access authority under [the Federal Power Act and the Natural Gas Act], our interpretation serves to err on the side of greater customer protection.17 Entities that had been determined to be EWGs prior to the effective date of the PUHCA 1935 repeal would retain that status. However, if FERC's proposal is put into effect, EWG status in many, if not most, cases probably would become meaningless in short order. For example, if a company that owned only EWGs prior to the effective date of the repeal of PUHCA 1935 were to acquire after that date a project through a new company, that company could not become an EWG. The owner of the new company therefore would become ineligible for an exemption from FERC access to books and records under PUHCA 2005, which would apply to the entire holding company system, including EWGs, QFs and FUCOs.18 For this reason, the holding company would have no incentive to maintain the EWG status of its other subsidiaries. At this time it is not possible to predict whether FERC will implement its proposal to cease making EWG determinations. It is worth noting, however, that the proposal met with little support and unusually sharp criticism from many quarters, including from the Chairman of the House Committee on Energy and Commerce.19 In any event, at this writing the procedures for a FERC determination of EWG status remain in place, and PUHCA 2005 retains the meaning of EWG contained in PUHCA 1935. A company wishing to qualify for EWG status must meet two basic interrelated requirements. First, the definition of EWG created by section 32 of PUHCA 1935 and incorporated into PUHCA 2005 provides that the company m u s t b ee n g a g e dd i r e c t l y , o r indirectly . . . and exclusively in the business of owning or operating, or both owning and operating, all or part of one or more eligible facilities and selling electric energy at
15 16 17 18 19
Id. at P 21. Id. at PP 21, 22. Id. at P 22 (emphasis supplied). EPAct 2005 1264(a), 119 Stat. at 974.
See, e.g., Reply Comments of Congressman Joe Barton, Repeal of the Public Utility Holding Company Act of 1935 and Enactment of the Public Utility Holding Company Act of 2005, Docket No. RM05-32-000, at 7-8 (Oct. 21, 2005).
260
20 w h o l e s a l e . Any generation facility that the company owns and/or operates must be an e l i g i b l e f a c i l i t y . S e c t i o n 3 2 d e f i n e s a n e l i g i b l e f a c i l i t y a s a f a c i l i t y u s e d f o r t h e g e n e r a t i o n 21 o f e l e c t r i c e n e r g y e x c l u s i v e l yf o r s a l e a t w h o l e s a l e . An eligible facility can consist of an undivided interest in a generation facility and can include necessary appurtenant interconnection facilities.22 Any facility that was in a retail rate base on October 21, 1992 cannot be considered to be an eligible facility unless every state commission with jurisdiction over the retail rates in question makes a determination that allowing the facility to be an eligible facility will benefit consumers, be in the public interest, and not violate state law.23 Moreover, no EWG may own or operate a portion of a facility if an affiliate public utility that is not an EWG owns or operates another portion of that facility unless the state commissions with jurisdiction over the retail rates for power from the facility make the findings listed in the previous sentence.24 EWGs meeting the definition of a public utility under the FPA are, and continue to be, subject to regulation as such by FERC.25
At least until the repeal of PUHCA 1935 becomes effective, and thereafter subject to the outcome of the pending PUHCA 2005 rulemaking, a company that wishes to become an EWG must file an application with FERC, which always has had responsibility for EWG matters.26 The application process generally is straight forward, and the core of the 27 a p p l i c a t i o n c o n s i s t s o f a n u m b e r o f r e p r e s e n t a t i o n s d e s c r i b e di n F E R C s E WGr e g u l a t i o n s . FERC staff requires that these representations be made using language that closely mirrors what is set forth in the regulations, and in some cases the staff will require an amendment to correct variations that could appear to the applicant to be insignificant.28
20 21
15 U.S.C. 79z-5a(a)(1) (repealed).
Id. 79z-5a(a)(2) (repealed). Eligible facilities may be located in the United States or abroad, and retail sales may be made from eligible facilities located in a foreign country provided that none of the energy generated by facility is sold to consumers in the United States. Id. 79z-5a(b) (repealed).
22 23
Id. 79z-5a(a)(2) (repealed).
Id. 79z-5a(c) (repealed). In the case of a registered holding company, these findings must be made by all state commissions with jurisdiction over the rates of any subsidiary of the holding company.
24 25 26
Id. 79z-5a(d) (repealed). PUHCA NOPR at P 23.
Section 32 of PUHCA 1935 made the determination of EWG status solely FERC s responsibility. Thus, unlike qualifying facility status under PURPA, which ultimately is based on the presence of certain necessary facts, the fulfillment of specific filing requirements is an absolute precondition to achieving EWG status.
27 28
18 C.F.R. 365.3 (2005).
FERC views the EWG application process to be essentially ministerial . Filing Requirements and Ministerial Procedures for Persons Seeking Exempt Wholesale Generator Status, Order No. 550, 58 Fed. Reg. 8897 (Feb. 18, 1993), FERC Stats. & Regs., Regs. Preambles 1991-1996 30,964, at 30,780 (1993).
EXEMPT WHOLESALE GENERATORS
261
A company submitting an application in good faith for a determination of EWG status will be deemed to be an EWG from the date the application is submitted.29 FERC has 60 days to act on the application.30 If FERC fails to act within that time period, the application will be deemed granted.31 In practice, however, FERC has rarely (if ever) failed to render a decision within the 60 day period. II. SPECIFIC POTENTIAL COMPLIANCE ISSUES
EWG compliance issues break down into two broad categories. The first category concerns the ongoing operations of the EWG itself and involves two basic issues. These correspond to the fundamental elements of EWG status, i.e., (a) being engaged exclusively in owning/operating one or more eligible facilities and (b) selling electricity exclusively at wholesale. The second category of compliance issues involves filing requirements, primarily the obligation to notify FERC of material changes in the facts relevant to EWG status. Particularly in light of the pending PUHCA 2005 rulemaking, it is not clear at this time the degree to which the repeal of PUHCA 1935 ultimately will cause FERC to reassess any aspect of its EWG policies. Thus, the following discussion of EWG compliance issues is b a s e d o n F E R C s a p p r o a c h t o E WGm a t t e r s p r i o r t o t h e repeal of PUHCA 1935. A. SCOPE OF EWG OPERATIONS 1. Basic Requirement As discussed above, EWGs must limit their business to owning and/or operating facilities used to generate electricity for sale at wholesale and engaging in such sales (the exclusivity requirement). 2. Refinements to Basic Requirement EWGs may engage in additional activities that do not fall within a strict reading of the statute, but that are deemed by FERC to be permissible as incidental to EWG operations.32 In general, FERC will allow EWGs to engage in any activity that would be recognized in the industry as normal for generators, but only to the extent that it is consistent with the basic requirement that EWGs restrict themselves to the wholesale generation business. For example, FERC will permit EWGs to resell excess fuel supplies and assign excess fuel transportation capacity, but only if they have not contracted for more gas and transportation than believed necessary to operate the facility. 33 Trading of emissions
29 30 31 32 33
15 U.S.C. 79z-5a(a)(1) (repealed); 18 C.F.R. 365.4. 15 U.S.C. 79z-5a(a)(1) (repealed). 18 C.F.R. 365.6. See, e.g., CMS Morocco Operating Co. SCA, 78 FERC 61,118, at 61,454 (1997). Selkirk Cogen Partners, L.P., 69 FERC 61,037 (1994).
262
allowances is also permitted, subject to similar provisos.34 The following are examples of other incidental activities that FERC has found to be appropriate for EWGs: Development activities necessary to develop the EWG's eligible facilities.35 Ownership and operation of landfill for disposal of coal combustion by-products from present and future EWG operations.36 Ownership of oil storage and transportation facilities that will be used by an affiliate to provide oil to the EWG and to third parties.37 Wholesale power marketing (i.e., purchasing and reselling electric energy at wholesale produced by third parties).38 Sale of ancillary services.39 Sale of generation by-products such as steam and fly ash. 40 Lease of property, although, depending on the type of property concerned, FERC either prohibits the EWG from receiving rental income or permits only receipt of nominal income.41 This list is illustrative, not exhaustive. From a compliance perspective, the key is to have systems in place to detect and analyze even slight variations in EWG activities. Although it often seems intuitive which activities are and which activities are not incidental to core EWG operations, FERC makes such determinations on a case-by-case basis. Therefore any activity not covered by existing FERC precedent is potentially problematic.
34 35 36 37
UGI Dev. Co., 89 FERC 61,192 (1999). Southern Elec. Wholesale Generators, Inc., 66 FERC 61,264 (1994). NRG Ne. Generating LLC, 88 FERC 61,190 (1999).
See Application of KeySpan-Ravenswood, Inc. for Determination of Exempt Wholesale Generator Status, Docket No. EG99-166-000 (June 9, 1999) (granted by KeySpan-Ravenswood, Inc., 88 FERC 62,073 (1999)).
38 39 40 41
Entergy Power Mktg. Corp., 73 FERC 61,063 (1995). Sithe Framingham LLC, 83 FERC 61,106 (1998). Richmond Power Enter., L.P., 62 FERC 61,157 (1993).
Killingholme Generation Ltd., 90 FERC 61,194 (2000). In this case FERC permitted the applicant to lease a combined cycle gas turbine simulator training facility for rental payments equaling 0.02 percent of its revenues from the sale of power. It also permitted the applicant to lease free of charge site property used for agricultural purposes.
EXEMPT WHOLESALE GENERATORS 3. Compliance Recommendations
263
In addition to requesting authority to engage in anticipated incidental activities, it is prudent for an EWG also to request advance authority for incidental activity that it has no present intent to engage in, but that it may engage in eventually, and that is routinely authorized under existing FERC precedent. This can reduce the need to make additional future filings with FERC. A company should develop protocols for decisionmaking regarding any acquisition by the EWG or any proposal to engage in activities beyond core wholesale generation operations. No acquisitions or expansion of activities should be undertaken without a determination by the company, and if necessary FERC, that the proposal is consistent with the restrictions placed on EWG operations. Note that potential issues can arise if s o m e o f t h e E WG s a s s e t s are transferred to a subsidiary. Transfers to subsidiaries of assets other than eligible facility components, e.g., necessary facility real estate transferred to a subsidiary of the EWG to gain tax advantages, can be consistent with EWG requirements because the EWG will retain indirect ownership. 42 On the other hand, holding c o m p o n e n t s o f a n E WG s eligible facility through affiliated companies can create significant issues, as the subsidiary might be considered to be an electric utility company under PUHCA or PUHCA 2005 but not qualify for EWG status on its own. FERC has approved such ownership structures,43 but EWGs should never transfer utility assets to a subsidiary without first seeking FERC approval. B. WHOLESALE SALES Congress originally enacted the EWG provisions of PUHCA 1935 as a means of promoting wholesale generation and competitive wholesale power markets generally. Congress also intended that EWGs not compete with retail utilities. FERC has been quite vigilant in enforcing this aspect of the statute.44
42 43
Vista Energy, L.P., 69 FERC 61,225 (1994).
Termoelectrica U.S., LLC, 102 FERC 61,019 (2003); Sagebrush, 103 FERC 61,332 (2003) (EWG s permitted to own interconnecting transmission facilities through subsidiary companies). It should be noted that any transfer by an EWG to a subsidiary of facilities subject to FERC jurisdiction under the FPA may require authorization under section 203 of the FPA. It should be noted that section 32(b) of PUHCA 1935 permits EWGs to sell electricity at retail from an eligible facility located in a foreign country, provided none of the energy generated from that facility is sold to consumers in the United States. 79z-5a(b) (repealed), While section 1262(6) of PUHCA 2005 explicitly i n c o r p o r a t e st h em e a n i n go ft h et e r m e x e m p tw h o l e s a l e g e n e r a t o r a su s e di ns e c t i o n3 2o f P U H C A1 9 3 5 , i t d o e sn o t r e f e r t ot h er e m a i n i n gp o r t i o n so f section 32, which were repealed by PUHCA 2005. In the event that FERC does not preserve this provision, it should be noted that any EWG that has no generating facilities located in the United States and that derives no income from the generation, transmission, or distribution of electric energy
44
264
ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK 1. Basic Requirement
As discussed above, EWGs are prohibited from selling electricity at retail and, instead, must be exclusively in the business of selling electric energy at wholesale.45 2. Refinements to Basic Requirement EWGs have been permitted to make sales that might be construed as retail transactions in very narrow circumstances, e.g., the provision of emergency back-up power directly to an end-use customer, a nuclear generating facility. 46 On the whole, however, the prohibition on retail sales is quite strict. Under limited circumstances an EWG may be permitted to operate facilities used to generate electricity sold at retail. An example of this w o u l d b e a s i t u a t i o n w h e r e t h e E WG s e l i g i b l e f a c i l i t y c o n s i s t e d o f a n u n d i v i d e d i n t e r e s t i n a generation facility, and other non-affiliated owners made retail sales from their undivided interests. FERC has authorized an EWG to operate the entire facility in such a case when it can be shown that it would be inefficient to have more than one entity responsible for overall operation of the facility.47 3. Compliance Recommendations The prohibition against retail sales is basic to the statutory requirements for EWGs, and the exceptions authorized by FERC are extremely narrow. EWGs therefore should seek prior FERC authorization before taking any action that might be construed as involving a sale of electric energy at retail. EWGs should include in power sales decision protocols standards for confirming (i) the identity of the power purchaser and (ii) that the sale in question is for resale. Where state law permits retail power marketing, an EWG may be able to avoid engaging in retail sales by interposing a power marketer between itself and the end user of the power.
in the United States is likely to be eligible for FUCO status. At this time it is not clear whether FERC will establish a procedure for creating new FUCOs in its final rules under PUHCA 2005. 15 U.S.C. 79z-5a(a) (repealed). In addition, section 32(k) of PUHCA 1935 provided that EWGs could not engage in direct or indirect sales at wholesale to affiliated franchised public u t i l i t i e s w i t h o u t p r i o r a u t h o r i z a t i o n f r o mt h e s t a t e c o m m i s s i o n ( s ) t h a t r e g u l a t e t h e u t i l i t y s r e t a i l r a t e s . Id. 79z-5a(k) (repealed). Although the language of PUHCA 2005 concerning EWGs is somewhat ambiguous, it is reasonable to conclude that PUHCA 2005 repealed the requirement of state approval for affiliate sales. It should be noted, however, that section 214 of the FPA makes such affiliate sales unlawful under section 205 of the FPA if FERC finds that the rates in question permit the EWG to receive any undue preference or advantage from the affiliate. 16 U.S.C. 824m.
46 47 45
Erie Boulevard Hydropower, L.P., 87 FERC 61,378 (1999).
PP&L Colstrip III, LLC, 88 FERC 61,281 (1999). In the circumstances of this case, FERC ruled that the applicant s operation of a generating station partly owned by others in faction w a s i n c i d e n t a l t o i t s o w n e r s h i p o f t h e r e s t o f t h a t s t a t i o n . Id. at 61,869.
EXEMPT WHOLESALE GENERATORS C. FILING REQUIREMENTS 1. Basic Requirements
265
The EWG application process is discussed in section I above. The only other EWG filing requirement involves notifying FERC of any material change in the facts that it relied on in granting the company EWG status.48 EWGs must file such a notification within 60 days of the change in facts.49 The filing must include either (a) a request for redetermination o f E WG s t a t u s , ( b ) a ne x p l a n a t i o no f w h yt h e c h a n g e d o e s n o t a f f e c t t h e c o m p a n y s E WG status, or (c) a notification that the company no longer seeks to maintain EWG status.50 2. Interpretation of the Basic Requirement Although the notification requirement is triggered by a n ym a t e r i a l c h a n g e i nf a c t s that may affect a company s eligibility for EWG status, FERC has not established in its regulations or elsewhere any standards for determining what specific changes should be considered material. Therefore, to avoid uncertainty, it has become common practice to interpret the requirement very broadly. For example, although the statute contains no limitations on what companies may acquire EWGs, it is standard practice for EWGs to notify FERC of changes in their upstream ownership. In fact, this is perhaps the most common reason that such notifications are filed. 3. Compliance Recommendations EWG notifications are most commonly acquisition-related, and checklists for transactions involving transfer of an interest in an EWG usually include an EWG notification to FERC. FERC does not require that EWG applications contain an elaborate description of upstream ownership. Therefore, the number of notification filings can be reduced simply by identifying only the ultimate upstream owner in the original EWG application, e.g., A p p l i c a n ti sa ni n d i r e c t ,w h o l l y -owned subsidiary of G e n e r a t i o nH o l d i n gC o m p a n y . T h i s e l i m i n a t e s a n ys u g g e s t i o nt h a t c h a n g e s i n the intermediate ownership structure need to be reported, as that structure was not considered in the EWG determination process. III. PENALTIES FOR VIOLATIONS There are no stated penalties for violations of EWG requirements other than the loss of EWG status itself through activities that are inconsistent with that status.51 Loss of EWG
48 49 50 51
18 C.F.R. 365.8. Id. Id.
As discussed in Chapter 3, EPAct 2005 greatly enhances FERC s civil penalty authority, but only with respect to violations of the FPA and the NGA. However, as noted above, section 214 of the FPA makes affiliate sales by EWGs unlawful under section 205 of the FPA if FERC finds that the
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status, in turn, leads to loss of an exemption that is conditioned upon that status. Under PUHCA 2005 that would mean loss of an exemption from provisions authorizing FERC access to holding company books and records for a company that owned only EWGs, QFs and FUCOs. As stated previously, it is unclear at this time how much benefit that exemption will confer, which means that the practical significance of losing EWG status also is unclear. But whatever practical significance losing EWG status might have, it will not be nearly as severe as the potential consequences of losing EWG status prior to the effective date of PUHCA 1935 repeal. Indeed, EWG status imposes its own constraints, i.e., the limitations created by the requirement that EWGs limit themselves to a narrow range of activities. Generation owners therefore should balance those limitations against the limited benefits of EWG status under PUHCA 2005 when considering whether to seek (or retain) EWG status for their project companies.
rates in question permit the EWG to receive any undue preference or advantage from the affiliate. FERC s civil penalty authority applies to this EWG-specific provision.
Chapter 16 Reliability Standards and Practices

DAVID J. HILL The massive power blackout of August 14, 20031 led to calls from many sectors of the electric power industry for stricter, compulsory operating reliability standards. Congress heeded these calls in the Energy Policy Act of 2005 ( E P A c t 2 0 0 5 ) ,2 which amended the F e d e r a l P o w e r A c t ( F P A ) t o give t h e F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n ( FERC o r C o m m i s s i o n ) the authority to certify a n E l e c t r i c R e l i a b i l i t y O r g a n i z a t i o n ( E R O ) that will establish and enforce mandatory reliability s t a n d a r d s ,s u b j e c tt oF E R C sr e v i e wa n d approval.3 On September 1, 2005, FERC issued a Notice of Proposed Rulemaking to 4 i m p l e m e n t t h en e ws t a t u t e sm a n d a t e s . However, the rulemaking is only the first step, establishing the framework for approving an ERO and for the ERO s adopting reliability standards and submitting them to FERC for approval. As of the time of this publication, there is still no single agency or set of rules to which a utility can look for enforceable requirements and compliance standards. And the task of developing such standards, which has been ongoing since 2003, will take years to complete and no doubt will remain a dynamic process as standards are reviewed and updated over time.
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Before joining Skadden in 2001, Mr. Hill served as a trial attorney in the Bureau of Competition in the Federal Trade Commission and was a partner in another Washington, D.C. law firm. He has represented electric utilities and marketers in a wide variety of litigated and related matters before FERC, as well as in proceedings before the CFTC. He also has represented both utilities and natural gas companies in complex contract disputes, antitrust matters, and internal corporate investigations. The joint U.S.-Canada Power System Outage Task Force created to investigate the b l a c k o u t s c a u s e s c o n c l u d e di n i t s A p r i l 5 , 2 0 0 4f i n a l r e p o r t t h a t t h e b l a c k o u t w a s p r e v e n t a b l e a n d had several direct causes and contributing factors, including: (a) failure to maintain adequate reactive power support; (b) failure to ensure operation within secure limits; (c) inadequate vegetation management; (d) inadequate operator training; (e) failure to identify emergency conditions and communicate that status to neighboring systems; and (f) inadequate regional-scale visibility over the bulk power system. See U.S.-Canada Power System Outage Task Force, Final Report on the August 14, 2003 Blackout in the United States and Canada: Causes and Recommendations, at 139 (Apr. 15, 2004), available at http://www.ferc.gov/cust-protect/moi/blackout.asp.
2 3 4 1
Pub. L. No. 109-58, 119 Stat. 594 (2005). See id. 1211, 119 Stat. at 941-46.
Rules Concerning Certification of the Electric Reliability Organization; and Procedures for the Establishment, Approval, and Enforcement of Electric Reliability Standards, Notice of Proposed Rulemaking, 70 Fed. Reg. 53,117 (Sept. 7, 2005), 112 FERC 6 1 , 2 3 9( 2 0 0 5 ) ( 2 0 0 5 R e l i a b i l i t yN O P R ) .U n d e r E P A c t 2 0 0 5 , F E R Ci s r e q u i r e dt oi s s u eaf i n a l r u l et oi m p l e m e n t t h e requirements of t h e s t a t u t e s r e l i a b i l i t y p r o v i s i o n s b y F e b r u a r y 5 , 2 0 0 6 .
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In view of the multi-faceted aspects of evolving reliability regulations and standards, this chapter is more descriptive than others in this Handbook. Nonetheless, all utilities have a vital interest in how standards are set, who is responsible for implementing them, who pays for what, how violations of standards will be determined, and what the consequences for noncompliance will be. This information, and the accompanying compliance recommendations, are provided for two reasons. First, we perceive that many companies place a high value on system reliability and want to be at the cutting edge of new practices and procedures. Second, companies that fall behind in this regard potentially risk not only system disruptions but also adverse regulatory consequences. 5 I. THE ENERGY POLICY ACT OF 2005
Title XII of EPAct 2005 created a new section 215 of the FPA e n t i t l e d E l e c t r i c 6 R e l i a b i l i t y . In brief, this new section provides as follows: A. JURISDICTION T h e C o m m i s s i o n s e x p a n d e d a u t h o r i t y r e l a t e d t o r e l i a b i l i t yi n c l u d e s j u r i s d i c t i o n o v e r the ERO it will certify a sw e l l a s a l l u s e r s ,o w n e r sa n do p e r a t o r so ft h eb u l k -power 7 s y s t e m . The latter includes entities such as municipal, state, and cooperative utilities, the T e n n e s s e e V a l l e yA u t h o r i t y( TVA ) , and federal power marketing agencies that otherwise are exempt from most provisions of the FPA. The C o m m i s s i o n s new authority also extends t oR e g i o n a l T r a n s m i s s i o n O r g a n i z a t i o n s ( R T O s ) , I n d e p e n d e n t S y s t e mO p e r a t o r s ( I S O s ) , 8 and similar transmission operating entities.
As discussed below, EPAct 2005 explicitly provides that companies may be penalized for violations of an approved reliability standard. See infra Part I.D. While the potential penalties for violations of these standards have not yet been established, EPAct 2005 substantially expanded the C o m m i s s i o n s a u t h o r i t yt oi m p o s e c i v i l p e n a l t i e s f o r v i o l a t i o n s o f t h e F P Ai na d d i t i o nt oi n c r e a s i n g the potential amounts of such penalties. See EPAct 2005 1284(e), 119 Stat. at 980 (amending FPA section 316A, 16 U.S.C. 825o-1 (2005)); see also Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 113 FERC 61,068, at PP 2, 22 (2005) ( Enforcement Policy Statement ) ( e x p l aining the factors FERC will rely upon in exercising this new authority). A detailed discussion of the amendments to FPA section 316A and the Enforcement Policy Statement is found in Chapter 3 of this Handbook.
6 7
EPAct 2005 1211, 119 Stat. at 941-46 (codified at 16 U.S.C. 824o).
16 U.S.C. 8 2 4 o ( b ) .T h et e r m b u l k -p o w e r s y s t e m m e a n s ( a ) f a c i l i t i e s a n dc o n t r o l systems necessary for operating an interconnected electric energy transmission network (or any p o r t i o nt h e r e o f ) a n d( b ) e l e c t r i c e n e r g y from generation facilities needed to maintain transmission s y s t e mr e l i a b i l i t y . Id. 8 2 4 ( a ) ( 1 ) .A b u l kp o w e r s y s t e m d o e s n o t i n c l u d e f a c i l i t i e s u s e di nt h e l o c a l d i s t r i b u t i o n o f e l e c t r i c e n e r g y . Id. See id. 8 2 4 o ( a ) ( 6 ) ( d e f i n i n gt h et e r m t r a n s m i s s i o no r g a n i z a t i o n ) .I f ac o n f l i c t i s determined to exist between an ERO reliability standard and the tariff of a transmission organization, t h et r a n s m i s s i o no r g a n i z a t i o n sa p p r o v e dt a r i f fw i l lc o n t i n u et og o v e r nu n t i ls u c ht i m ea st h e Commission approves a modification in the ERO reliability standard or the transmission o r g a n i z a t i o n s t a r i f f . See id. 824o(d)(6).
8
RELIABILITY STANDARDS AND PRACTICES B. CERTIFICATION OF THE ERO
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FERC is authorized to certify one ERO.9 T h e E R Om u s t h a v e t h e a b i l i t y to develop and enforce . . . reliability standards that provide for an adequate level of reliability of the 10 bulk-p o w e rs y s t e m . In addition, the ERO must adopt rules that, inter alia, assure independence and fair stakeholder participation and provide for fair and impartial enforcement of reliability standards. 11 In anticipation of the passage of reliability legislation, the North American Electric R e l i a b i l i t yC o u n c i l ( N E R C ) has begun the process of restructuring itself to become the 12 new ERO. N E R C se f f o r t si n c l u d e modifying its governance structure to meet the requirements of the reliability legislation, updating existing reliability standards to assure clarity and enforceability (if they are adopted on an interim basis), and exploring alternative funding mechanisms to ensure that adequate resources will be available to develop and implement whatever reliability rules FERC ultimately approves. But considerable work in all of these areas remains to be done. C. ERO RELIABILITY STANDARDS
13 Although the process of developing and enforcing reliability standards is vested with the ERO, all such standards and enforcement procedures must be filed with and approved by FERC prior to implementation. 14 The standard for Commission review and approval of ERO proposals contains terms familiar from other provisions of the FPA. (FERC may approve rules proposed by the ERO if FERC finds the rules just, reasonable, not unduly discriminatory, and in the public interest.)15 However, Congress also appeared to contemplate some level of FERC deference to t h e E R O , p r o v i d i n g t h a t F E R C shall give due
9 10 11 12
See id. 824o(c). Id. 824o(c)(1). See id. 824o(c)(2).
EPAct 2005, however, does not preclude any other organization from seeking FERC certification. See id. 8 2 4 o ( c ) ( p r o v i d i n g t h a t a n y p e r s o n m a y s u b m i t a n a p p l i c a t i o n ) . U n d e r E P A c t 2 0 0 5 , t h et e r m r e l i a b i l i t ys t a n d a r d m e a n s ar e q u i r e m e n t , a p p r o v e db y the Commission under this section, to provide for reliable operation of the bulk-power system. The term includes requirements for the operation of existing bulk-power system facilities, including cybersecurity protection, and the design of planned additions or modifications to such facilities to the extent necessary to provide for reliable operation of the bulk-power system, but the term does not include any requirement to enlarge such facilities or to construct new transmission capacity or g e n e r a t i o n c a p a c i t y . 1 6 U . S . C . 8 2 4 o ( a ) ( 3 ) . I n t u r n , t h e t e r m r e l i a b l e o p e r a t i o n m e a n s o p e r a t i n g the elements of the bulk-power system within equipment and electric system thermal, voltage, and stability limits so that instability, uncontrolled separation, or cascading failures of such system will not occur as a result of a sudden disturbance, including a cybersecurity incident, or unanticipated f a i l u r e o f s y s t e me l e m e n t s . Id. 824o(a)(4).
13
See id. 824o(d). See Part III of this chapter for a discussion of NERC's Version 0 and Version 1 r e l i a b i l i t y s t a n d a r d s .
14 15
See id. 824o(d)(2).
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wei g h t t ot h e t e c h n i c a l e x p e r t i s e of the ERO, b u t s h a l l n o t d e f e r w i t h r e s p e c t t ot h e e f f e c t 16 of a standa r do nc o m p e t i t i o n . FERC may remand proposed rules back to the ERO for revision or reconsideration if FERC concludes that a proposed rule does not meet these standards.17 The Commission also is authorized to direct the ERO to file a rule addressing a specific reliability-related concern or modify an existing rule. 18 D. ENFORCEMENT OF RELIABILITY STANDARDS In contrast to the current voluntary system of NERC and regional council reliability guidelines, the ERO is authorized to penalize a user, owner, or operator of the bulk power system for violations of an approved reliability standard. 19 Enforcement actions undertaken by the ERO must conform to established procedural guidelines to protect the rights of the relevant market participants. In particular, the notice and record of any enforcement proceeding must be filed with FERC, and any penalties imposed by the ERO may be reviewed and modified by the Commission.20 While the ERO is expected to take the lead on reliability monitoring and enforcement, FERC may initiate an enforcement action on its own behalf; direct a user, owner, or operator to comply with a reliability standard; and impose penalties for violations.21 The Commission is not authorized to preempt State authority unless the State has taken action or adopted regulations that are shown to be inconsistent with a reliability standard adopted by the ERO and approved by FERC.22 E. REGIONAL ENTITIES The ERO is authorized to enter into agreements whereby it may delegate certain of its 23 rulemaking and enforcemen t a u t h o r i t i e s t o r e g i o n a l e n t i t i e s . A regional entity must be governed by an independent board, a balanced stakeholder board, or a combination of both, and otherwise satisfy the requirements of an ERO.24 The agreement with the regional entity
16 17 18 19 20 21 22 23
Id. See id. 824o(d)(4). See id. 824o(d)(5). See id. 824o(e)(1). See id. 824o(e)(2). See id. 824o(e)(3). See id. 824o(i)(3).
Id. 8 2 4 o ( e ) ( 4 ) .N e i t h e r E P A c t 2 0 0 5n o r F E R C sp r o p o s e dr e g u l a t i o n sd e s cribe the t y p e s o f e n t i t i e s t h a t a r ee l i g i b l et ob e c o m e r e g i o n a l e n t i t i e s . A t l e a s t i nt h es h o r t t e r m , s u c h entities likely will be one or more of the existing NERC regional reliability councils, such as the Southeastern Electric Reliability Council ( S E R C ) .I n t h e 2 0 0 5R e l i a b i l i t y N O P R , F E R Co b s e r v e d t h a t t h e b i l a t e r a l p r i n c i p l e s [ i.e., agreements between the U.S. and Canada] provide that RTOs and ISOs should not become Regional Entities and that the Regional Entities should be distinct from the ope r a t o r s o f t h e s y s t e m , s u c h a s R T O s a n d I S O s . 1 1 2 F E R C 61,239 at P 71(9).
24
See 16 U.S.C. 824o(e)(4)(A)-(B).
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25 must prom o t e e f f e c t i v e a n d e f f i c i e n t a d m i n i s t r a t i o n o f b u l k -p o w e r s y s t e mr e l i a b i l i t y . The ERO and FERC shall rebuttably presume that a proposal for delegation to a regional entity organized on an Interconnection-wide basis (i.e., a geographic area in which the operation of bulk-power system components is synchronized to maintain reliable operation) promotes effective and efficient administration of bulk-power system reliability and should be approved.26 Also, rules of a regional entity organized on an Interconnection-wide basis will be rebuttably presumed by the ERO to be just, reasonable, not unduly discriminatory, and in the public interest.27
F. REGIONAL ADVISORY BODIES AND INTERNATIONAL COOPERATION Upon petition o f t h eS t a t e sw i t h i nar e g i o n , a r e g i o n a l a d v i s o r yb o d y o f S t a t e 28 participants may be established to advise the ERO, a regional entity, or the Commission. In a d d i t i o n ,C o n g r e s su r g e dt h eP r e s i d e n t t on e g o t i a t ei n t e r n a t i o n a la g r e e m e n t sw i t ht h e governments of Canada and Mexico to provide for effective compliance with reliability 29 s t a n d a r d s . In fact, FERC has worked closely with Canadian authorities since the August 2003 blackout, including through a series of joint conferences and the formation of a Bilateral Electric Reliability Oversight Group. G. SIGNIFICANT UNCERTAINTIES IN IMPLEMENTATION Notwithstanding broad support for the reliability provisions of EPAct 2005, the process of establishing the new ERO and promulgating reliability standards is likely to draw a lot of attention and mirror many of the debates encountered in the development of RTOs. For example, new market entrants and traditional utilities have long differed on the competitive impact of reliability standards. Similarly, long-standing tensions between investor-owned utilities and the public power sector could be exacerbated as the latter become subject to FERC oversight for reliability purposes. Other debates will focus on how much regional variation should be allowed in the reliability standards and penalties and in the development process, how the existing NERC and regional reliability apparatus could be folded into the new ERO and the regional organizations to which it will delegate authority, and whether FERC should consider approving (and making enforceable) part of a package of standards if it is not prepared to approve the entire package. ERO or FERC reliability mandates also could trigger tension with state regulators, particularly if the outcome of such mandates is higher costs to end-use customers or if such mandates spill over to operations of local distribution facilities where the new legislation clearly limits ERO authority. New cost burdens could be especially problematic if there is
25 26 27 28 29
See id. 824o(e)(4)(C). See id. 824o(e)(4). See id. 824o(d)(3). See id. 824o(j). See id. 824o(h).
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not a clear geographic nexus between improved reliability and those bearing the costs of the new reliability mandates. F i n a l l y , F E R C s 2005 Reliability N O P Ri d e n t i f i e s t h e a g e n c y s o w nq u e s t i o n s a b o u t how best to implement section 215. These questions include: How should ERO funding mechanisms, including the allocation of reasonable fees and charges to end users, be structured, and what is the scope of the term 30 e n d u s e r s ? What deference, if any, should FERC give to the technical determinations and r e l i a b i l i t yp r o p o s a l so f r e g i o n a le n t i t i e s t h a ta r en o to r g a n i z e do na n 31 Interconnection-wide basis? How should FERC implement the provision that it will not defer to the ERO or a regional entity with respect to the effect o n c o m p e t i t i o n of a Reliability Standard or modification to such a standard?32 Whether membership in the ERO or a Regional Entity should be a condition f o r p a r t i c i p a t i o ni nt h e E R O s o r aR e g i o n a l E n t i t y s s t a n d a r d s d e v e l o p m e n t 33 processes? How penalties should be determined and what procedures are necessary to provide sufficient due process during enforcement hearings and on appeal?34 What are the mechanisms for ensuring that FERC receives timely information regarding all potential violations of Reliability Standards?35 Whether the ERO s and regional entities enforcement roles should include features of other self-regulatory organizations, e.g., the National Association of Securities Dealers and the New York Mercantile Exchange?36 What should be the nature and extent of FERC regulation and oversight with respect to regional entities?37
30 31 32 33 34 35 36 37
2005 Reliability NOPR, 112 FERC 61,239 at P 43. Id. at P 46. Id. at P 48. Id. at P 56. Id. at PP 58-66. Id. at P 67. Id. at PP 68-73. Id. at P 84.
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On April 19, 2004, the Commission issued a Policy Statement on Matters Related to Bulk Power System Reliability.38 Although some aspects of this policy statement have been m o o t e db yo r s u b s u m e dw i t h i nt h en e ws e c t i o n2 1 5a n dF E R C s p r o p o s e dr e g u l a t i o n s , t h e following points are worth noting: The Commission will continue its policy of taking reliability considerations into account before authorizing a new ISO or RTO to become operational.39 T h eC o m m i s s i o ni n t e r p r e t s t h et e r m G o o dU t i l i t yP r a c t i c e , a s s e t f o r t hi n t h e C o m m i s s i o n s pro forma Open A c c e s s T r a n s m i s s i o n T a r i f f ( OATT ) , to include compliance with NERC reliability standards or more stringent regional reliability council standards.40 In addition, although recognizing the need for regional variations, FERC will not accept inferior standards.41 F E R Ca l s oi s s u e da w a r n i n gt ou t i l i t i e s t oc o m p l yw i t hN E R Cr e l i a b i l i t ys t a n d a r d s and to remedy any deficiencies identified in NERC compliance audit reports and r e c o m m e n d a t i o n s o r r i s k t h e C o m m i s s i o n 's t a k i n g u t i l i t y-specific action on a case-by-case b a s i s , which could include a finding that rates are unjust and unreasonable and denial of full cost recovery.42
107 FERC 6 1 , 0 5 2( 2 0 0 4 ) ( R e l i a b i l i t yP o l i c yS t a t e m e n t ) , clarified, Supplement to Policy Statement on Matters Related to Bulk Power System Reliability, 110 FERC 61,096 (2005) ( S u p p l e m e n t a l R e l i a b i l i t yP o l i c yS t a t e m e n t ) .A c t i n gp u r s u a n t t oi t s i n v e s t i g a t i v e a u t h o r i t yu n d e r section 311 of the FPA, 16 U.S.C. 825j (2000), FERC contemporaneously issued a companion order to the Reliability Policy Statement d i r e c t i n g a l l e n t i t i e s t h a t o w n , c o n t r o l o r o p e r a t e d e s i g n a t e d transmission facilities in the lower 48 States, . . . whether or not they are otherwise subject to the C o m m i s s i o n s j u r i s d i c t i o na s a p u b lic utility, to report on the vegetation management practices they now use for those transmission lines and rights-of-w a y s . Reporting by Transmission Providers On Vegetation Management Practices Related To Designated Transmission Facilities, Order Requiring Reporting On Vegetation Management Practices Related To Designated Transmission Facilities, 107 FERC 61,053 (2004). Further underscoring its increased oversight of reliability matters, FERC created a new Division of Reliability within its Office of Markets, Tariffs and Rates. See Reliability Policy Statement, 107 FERC 61,052 at P 10. This group includes experienced agency engineers and consultants with extensive expertise in grid operations, reliability and regulatory issues.
38 39 40
See id. at PP 24, 36.
Id. at P 23; see also Supplemental Reliability Policy Statement, 110 FERC 61,096 ( c l a r i f y i n gt h a t G o o dU t i l i t yP r a c t i c e u n d e rt h epro forma Open Access Transmission Tariff requires compliance with Version 0 Reliability Standards approved by NERC on February 8, 2005). Reliability Policy Statement, 107 FERC 61,052 at P 1 8( R e g i o n a l o r S t a t e s t a n d a r d s that do not account for physical differences and do not produce the same or a higher level of p e r f o r m a n c e a r e n o t a c c e p t a b l e . ) .
41 42
Id. at P 25.
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Having raised the stick, the Commission then offered two carrots. First, it assured public utilities that i tw o u l d a p p r o v ea p p l i c a t i o n st or e c o v e rp r u d e n t l yi n c u r r e dc o s t s necessary to ensure bulk electric system reliability, including prudent expenditures for vegetation management, improved grid management and monitoring equipment, operator 43 training, and co m p l i a n c ew i t hN E R Cr e l i a b i l i t ys t a n d a r d sa n dG o o dU t i l i t yP r a c t i c e s . Second, i t p r o m i s e dt o c o n s i d e r , o nac a s e -by-case basis, proposals by public utilities to a m e n dt h e i r O A T T s t oi n c l u d e l i m i t a t i o n s o nl i a b i l i t y w h i l e t a k i n ga c t i o n s t oc o m p l yw i t h NERC reliability standards. 44 III. NERC AND OTHER ACTIONS
Two NERC initiatives that pre-date EPAct 2005 are important. First, in February 2 0 0 4 , N E R Ce s t a b l i s h e da r e a d i n e s s a u d i t p r o g r a m t oa s s e s s , o nat h r e e -year cycle, the capability of all control areas and reliability coordinators to perform their reliability functions. According to its web site, as of September 30, 2005, NERC had completed 73 onsite audits for control areas, reliability coordinators, and transmission operators. NERC expects to complete the initial round of audits for all 150 control areas and 17 reliability coordinators by the end of 2006. Second, NERC put into effect, on April 1, 2005, its so-c a l l e d V e r s i o n0 s t a n d a r d s , which FERC described in its 2005 Reliability N O P Ra st h e t r a nslat[ion of] NERC Operating Policies, Planning Standards and compliance requirements into a comprehensive 45 s e t o f m e a s u r a b l e s t a n d a r d s . I t h a s b e e n N E R C s p l a n , n o ws u b j e c t t o t h e E R Op r o v i s i o n s of the new statute, to proceed to its next step Version 1 which is intended to strengthen its standards and add new ones. These standards are, for the most part, highly technical and will form the heart of the mandatory compliance process. Some of the ten regional reliability councils that are part of NERC and that may b e c o m e r e g i o n a l e n t i t i e s u n d e r EPAct 2005 also have been active. For example, ECAR conducted its own technical blackout investigation, which focused on the system behavior during the events leading up to and through the blackout, on the system response to the various events, and on the behavior of the protective relaying systems as the events progressed throughout the afternoon of August 14, 2003. In February 2004, ECAR issued its technical report on the blackout in conjunction with a separate recommendations report. IV. REGULATORY COMPLIANCE CONSIDERATIONS
As described above, the implementation of section 215, the certification of an ERO, and the development of all necessary standards and procedures remain moving targets. What is clear, however, is that electric utilities need to be active in the process of improving standards (including their completeness and clarity), emphasizing operator training, expanding communication protocols, and so forth. This means, among other things, that:
43 44 45
Id. at PP 27-28. Id. at P 40. 2005 Reliability NOPR, 112 FERC 61,239 at P 3.
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Utilities should consider actively participating in FERC, NERC, regional council and other processes. Utilities may not want to wait for NERC r e a d i n e s s a u d i t s t o r e v i e wt h e i r o w n p r a c t i c e s . Utilities should point out regional differences, especially on such things as vegetation management, but they may find it difficult to use such differences as an excuse to avoid addressing core reliability issues. Utilities should address the important issues relating to transmission pricing incentives, cost recovery, and third-party liability. Utilities should review applicable NERC and regional reliability standards and develop a program for assessing compliance and for periodic monitoring.
Chapter 17 Regional Transmission Organization And Market Monitor Requirements

GLEN BERNSTEIN Since Order No. 888, t h eF e d e r a lE n e r g yR e g u l a t o r yC o m m i s s i o n( FERCo r 1 C o m m i s s i o n ) policy has been to promote independent control over transmission. In Order No. 2000, FERC promoted independent control of transmission by encouraging the development of Regional Transmission Organizations ( RTOs ).2 Once established, RTOs typically have or develop pervasive roles in the operation of electric transmission systems and electricity markets in their respective regions. They often are control area operators, market administrators, regional transmission planners, and North American Electric Reliability Council ( N E R C ) reliability coordinators. RTOs have adopted complex and often interrelated sets of agreements and rules that apply to these roles, and use market monitoring units ( MMUs ) to provide oversight over market participant behavior. RTOs and MMUs are not governmental entities. Nonetheless, a failure to comply with RTO and market monitor rules and requirements can have significant financial impacts on market participants. In this chapter we will provide a broad overview of RTO structures and rules relating to governance, scheduling and data requirements, and market monitoring,
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Bernstein has represented electric utilities, governmental agencies, and generators in a wide variety of FERC and state matters. A significant focus of Mr. Bernstein's practice has related to the establishment of Regional Transmission Organizations and other independent transmission entities, and on-going matters addressing Regional Transmission Organization governance, market rules, and transmission pricing. See Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Servs. by Pub. Utils.; Recovery of Stranded Costs by Pub. Utils. and Transmitting Utils., Order No. 888, 61 Fed. Reg. 21,540 (May 10, 1996), FERC Stats. & Regs., Regs. Preambles Jan. 1991-J u n e 1 9 9 6 3 1 , 0 3 6( 1 9 9 6 ) ( O r d e r N o . 8 8 8 ) , o r d e r o nr e h g , Order No. 888-A, 62 Fed. Reg. 12,274 (Mar. 14, 1997), FERC Stats. & Regs., Regs. Preambles July 1996-Dec. 2000 31,048, o r d e r o nr e h g , Order No. 888-B, 81 FERC 61,248 (1997), o r d e r o nr e h g , Order No. 888-C, 82 FERC 61,046 (1998), a f f di nr e l e v a n t p a r t s u bn o m . T r a n s m i s s i o nA c c e s s P o l i c y S t u d y G r o u pv . FERC, 225 F.3d 667 (D.C. Cir. 2000), a f f ds u bn o m . N e wY o r kv . F E RC, 535 U.S. 1 (2002). In Order No. 888, FERC set out certain principles regarding properly-structured Independent System O p e r a t o r s ( I S O s ) i no r d e r t oe n c o u r a g e t h e f o r m a t i o no f p r o p e r l y -structured ISOs. See Order No. 888 31,036 at 31,730-32. See, e.g., Regional Transmission Orgs., Order No. 2000, 65 Fed. Reg. 809 (Jan. 6, 2000), F E R CS t a t . &R e g s . , R e g s . P r e a m b l e s J u l y 1 9 9 6 t o D e c . 2 0 0 0 3 1 , 0 8 9 , a t 3 1 , 1 9 3 ( 1 9 9 9 ) ( O r d e r N o . 2 0 0 0 ) , o r d e r o n r e h g , Order No. 2000-A, 65 Fed. Reg. 12,088 (Mar. 8, 2000), FERC Stat. & Regs., Regs. Preambles July 1996 to Dec. 2000 31,092 (2000), appeal dismissed for want of standing sub nom. Public. Util. Dist. No. 1 of Snohomish County v. FERC, 272 F.3d 607 (D.C. Cir. 2001).
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and we will explain some of the implications of failing to comply with those rules. We will not provide a detailed analysis of each RTO or each RTO rule, but rather will describe typical issues that can arise and provide examples of requirements that transmission owners, generators, and load serving entities ( LSEs ) must satisfy. 3 The compliance program of a particular party within an RTO ultimately will depend on the rules of the specific RTO, the extent of the party s operations in the RTO, and the party s financial and other interests. I. GOVERNANCE Under Order No. 2000, RTOs are required to be independenti.e., to have no financial interests in, and a decision-making process independent of, the control of any market participant or class of market participants in the region.4 To achieve independence, RTOs often utilize two-tiered governance structures. Under such structures, an independent board typically is charged with ensuring that the RTO safely and reliably operates the grid and creates and operates fair energy markets. 5 A stakeholder committee or group of stakeholder committees typically advises the board, and transmission owners sometimes retain the right to make changes to rates and rate design. 6 Stakeholder committees are comprised of voting sectors representing generation owners, other suppliers, transmission owners, electric distribution companies, LSEs, and consumers.7 A participant in an RTO is not obligated to participate in the RTO s governance structure or stakeholder processes. However, given the importance of the RTO s rules on a party s operations within that RTO, it normally is advisable to participate in the stakeholder processes that are available. Doing so can help ensure that the participant s interests are represented both in stakeholder votes and when stakeholder views are expressed to the RTO board. Because FERC often will provide a level of deference to filings made by RTOs, 8 it is advisable to participate in RTO processes and seek to influence RTO rules before RTO
B e c a u s e P J MI n t e r c o n n e c t i o n , L . L . C . ( P J M ) m a r k e t s a n d g o v e r n a n c e o f t e n h a v e b e e n a model for development of RTOs in other regions, we typically will point to PJM rules when discussing participation in RTOs.
3 4 5
See Order No. 2000 at 31,046-47; 18 C.F.R. 35.34(j)(1).
See, e.g., Agreement of Transmission Facilities Owners to Organize the Midwest Independent Transmission System Operator, Inc. at 22-23, available at http://www.midwestiso.org ( MI S OT OA g r e e m e n t ) . Ab o a r d m e m b e r o n a n i n d e p e n d e n t b o a r d c a n h a v e n o p e r s o n a l a f f i l i a t i o n or ongoing professional relationship with, or any financial stake in, any relevant market participant. See, e.g., Alliance Cos., 89 FERC 61,298, at 61,927-28 (1999). See, e.g., MISO TO Agreement at 43-46; PJM Transmission Owners Agreement at 1212B, available at http://www.pjm.com/documents/agreements.html ( P J MT OA g r e e m e n t ) . See, e.g., MISO TO Agreement at 43; Amended and Restated Operating Agreement of PJM Interconnection, LLC at 34, available at http://www.pjm.com/documents/agreements.html ( P J MO p e r a t i n g A g r e e m e n t ) . See, e.g., Midwest Indep. Transmission Sys. Operator, Inc., 108 FERC 61,027, at P 50 (2004); New York Indep. Sys. Operator, Inc., 104 FERC 61,311, at P 29 (2003); PJM Interconnection, LLC, 104 FERC 61,309, at P 19 (2003).
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filings are made at FERC. A program for monitoring all relevant filings at FERC also should be established so that parties may participate in FERC proceedings as appropriate. II. DATA, SCHEDULING, AND RELIABILITY REQUIREMENTS RTO rules include a number of scheduling and data requirements that apply to RTO members and market participants. For example, a transmission owner in an RTO maintains operational control over and ownership of its transmission facilities, but transfers functional control to the RTO. 9 This split in responsibilities leads to a number of data and other obligations transmission owners must satisfy, including: An RTO typically relies on its member transmission owners to prepare data inputs, such as load forecasts, for transmission models.10 The same is true for data inputs used for system planning models, such as developing inputs on expected generation dispatch levels and the dates for outages.11 RTOs also rely on transmission owners in the development of, and inputs used in, expansion plans, facilities studies, and mitigation plans.12 RTO rules typically do not provide for direct penalties for failures to meet these obligations. However, such a failure can adversely affect the RTO s ability to meet its obligations under its open-access transmission tariff ( OATT ), and there is reason to believe that FERC will use its increased penalty powers under the Energy Policy Act of 2005 ( E P A c t 2 0 0 5 )13 to address future transmission provider and transmission owner actions that result in violations of an OATT or FERC rules.14 Transmission owners typically must request RTO approval for planned outages of transmission facilities. In PJM, when an outage request is made within the specified time limits, PJM will approve the request so long as reliability can be maintained (economics are not taken into account). 15 If
9 10
See, e.g., PJM TO Agreement at 8.
See, e.g., PJM Operating Agreement at 90, 184; PJM Manual 3: Transmission Operations at 18-19, available at http://www.pjm.com/contributions/pjm-manuals/manuals.html; MISO TO Agreement at 107, 114. See, e.g., MISO TO Agreement at 162; PJM TO Agreement at 9; Southwest Power Pool Open-Access Transmission Tariff, Attachment O 1.0, available at http://www.spp.org/ Publications/SPP_Tariff_10-25-0 5 . d o c ( S P PO A T T ) . See SPP OATT, Attachment O 2.0, 19.4; MISO TO Agreement at 110; PJM OATT 36.11, available at http://www.pjm.com/documents/agreements.html.
13 14 12 11
Pub. L. No. 109-58, 119 Stat. 594.
Cf. Preventing Undue Discrimination and Preference in Transmission Servs. , Notice of Inquiry, 112 FERC 61,299, at P 15 (2005) (discussing penalties for OATT violations). See West Transmission Owners Agreement among PJM Interconnection, LLC, and Certain Owners of Electric Transmission Facilities at 8-9, available at http://www.pjm.com/ documents/agreements.html.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK adequate prior notice is not provided, however, PJM can deny a request (other than an emergency outage) based on the outage s impact on congestion. 16 Denials of outage requests can result in a number of costs, such as the need to reschedule work crews. In PJM, transmission system operators performing daily operations at the direction of the PJM System Operator must obtain PJM certification.17
Of course, data and scheduling requirements are not limited to transmission owners; many requirements also apply to generators and LSEs. Indeed, the direct or indirect costs associated with failing to meet scheduling deadlines often can be greatest for a party that is selling power or seeking to purchase power in RTO markets. Some examples of requirements that apply to LSEs and generators are: If a generator or LSE fails to submit a bid in a day-ahead market operated by an RTO, that generator or LSE may have to transact to a greater extent through the RTO s real-time market. Market participants often prefer to transact in the day-ahead market to obtain price certainty and avoid the fluctuations that can occur when transacting on a real-time basis. Generally, two types of transmission services are available under OATTs network integration transmission service and point-to-point transmission ( PTP ) service. All load in PJM is served using network transmission service, while export transactions and wheel-through transactions must reserve PTP service. A network customer is not required to schedule its expected use of the system, but non-network customers must. 18 Failure to meet these scheduling requirements can adversely affect a party s ability to make off-system sales. Explicit penalties sometimes apply to market participants that fail to comply with RTO scheduling requirements. For example, a generator in PJM that fails to obtain approval for a maintenance outage on a timely basis will be subject to a Peak Period Maintenance Penalty.19 Rule 1 of FERC's Market Behavior Rules requires that sellers with marketb a s e dr a t ea u t h o r i t y o p e r a t ea n ds c h e d u l eg e n e r a t i n gf a c i l i t i e s , u n d e r t a k e maintenance, declare outages, and commit or otherwise bid supply in a
16 17
See id.
See PJM Manual 01: Control Center Requirements at 21-22, available at http://www.pjm.com/contributions/pjm-manuals/manuals.html; PJM Manual 14D: Generator Operational Requirements at 47-48, available at http://www.pjm.com/contributions/pjmmanuals/manuals.html.
18 19
See, e.g., PJM OATT at 13.8 (addressing schedules for firm PTP transmission service). at 13, available at
See, e.g., PJM Manual 17: Capacity Obligations http://www.pjm.com/contributions/pjm-manuals/manuals.html.
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manner that complies with the Commission-approved rules and regulations of 20 t h e a p p l i c a b l e p o w e r m a r k e t . As these examples make clear, the implications for failing to comply with RTO data and scheduling requirements vary greatly, but the financial implications can be significant. It therefore is important to ensure that all such requirements are identified and understood. RTOs often provide extensive training programs, including programs that address data and scheduling requirements. Participants in RTOs are well-advised to take advantage of that training and to establish a program that will ensure that all such requirements are satisfied. RTOs also impose reliability requirements on control area operators in the RTO s region. For example, under t h eMi d w e s tI n d e p e n d e n tT r a n s m i s s i o nS y s t e mO p e r a t o r s ( MISO ) tariff, control areas must follow MISO s directives, its business practices, and NERC guidelines. This requirement is broadly stated in the MISO's Open Access Transmission and Energy Markets T a r i f f ( EMT ) , which requires a control area operator to: (iii) comply with the applicable policies, standards and requirements of the Commission, NERC and the applicable Regional Reliability Councils; and (iv) comply with the procedures established by the Transmission Provider for the operation of the Control Areas in the Transmission Provider Region in order to allow the Transmission Provider to fulfill its responsibilities under this Tariff.21
Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, Order Amending Market-Based Rate Tariffs and Authorizations, 105 FERC 61,218 a t A p p . A( 2 0 0 3 ) ( Market Behavior Rules Order ), r e h g d e n i e d , 107 FERC 61,175 (2004), appeal docketed, Cinergy Mktg. & Trading, LP v. FERC, No. 04-1168 (D.C. Cir. filed May 28, 2004). In response to EPAct 2005, FERC recently has issued several orders and notices of proposed rulemaking that would replace the Market Behavior Rules with new market manipulation rules. See Prohibition of Energy Market Manipulation, Notice of Proposed Rulemaking, 113 FERC 61,067 (2005) (proposing new regulations to implement Federal Power Act section 222 and Natural Gas Act section 4a); Investigation of Terms and Conditions of Public Utility Market-Based Rate Authorizations, 113 FERC 61,190 (2005) (proposing repeal of the Market Behavior Rules once final Market Manipulation Rules are issued and FERC has incorporated other aspects of the Market Behavior Rules into appropriate Commission orders, rules and regulations); Amendments to Codes of Conduct for Unbundled Sales Service and for Persons Holding Blanket Marketing Certificates, Notice of Proposed Rulemaking, 113 FERC 61,189 (2005) (proposing to repeal regulations requiring pipelines and all gas sellers for resale to adhere to a code of conduct once the final Market Manipulation Rules are issued and FERC has incorporated other aspects of the gas code of conduct rules into appropriate Commission orders, rules and regulations). See discussion in Chapter 9 of this Handbook (Market Behavior Rules).
21
20
EMT 38.6.1; see Midwest Indep. Transmission Sys. Operator, Inc., 110 FERC 61,289
(2005).
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In addition, some requirements for maintaining reliability will apply to a broad array of entities not just control areas. 22 III. MARKET MONITORING MMUs monitor organized wholesale markets to identify ineffective market rules and potential anticompetitive behavior in those markets.23 An MMU may administer compliance with OATT provisions only if the rules are expressly set forth in the RTO s OATT, involve objectively identifiable behavior, and do not subject market participants to sanctions or consequences other than those expressly approved by FERC.24 Further, any penalties must be designed to be a clear deterrent to unwanted behavior, without being so high as to be unnecessarily punitive. 25 In undertaking these roles, MMUs can impose a number of requirements on participants in RTO markets. These requirements relate largely to data requirements, responding to market mitigation, and answering claims that a market participant may have engaged in improper behavior. For example, in MISO, the MMU must refer certain perceived tariff violations to FERC, and FERC will determine whether to assess the penalties specified in the tariff.26 In PJM, the MMU must notify FERC immediately upon determining that it has identified a significant market problem that may require (a) further investigation, (b) a change in the PJM
See, e.g., E MT 3 8 . 2 . 5 ( a ) ( i ) ( r e q u i r i n ge a c hMa r k e t P a r t i c i p a n t t o c o m p l yw i t ht h e p r o c e d u r e se s t a b l i s h e df o r o p e r a t i o nb yt h eT r a n s m i s s i o nP r o v i d e r ) ; id. 38.2.5(a)(ii) (requiring each Market Participant to operate its resources consistent with the direction of the Transmission Provider); id. 3 8 . 2 . 5 ( d ) ( v )( r e q u i r i n gt h a tL S E sf o l l o w MI S O sd i r e c t i o n sr e g a r d i n gl o a d m a n a g e m e n t a n d r e s p o n d t oo t h e r T r a n s m ission Provider directives, issued pursuant to the terms of t h i st a r i f f , s u c ha st h o s er e q u i r e dd u r i n gE m e r g e n c yo p e r a t i o n s ) ;see also Chapter 16 of this Handbook (Reliability Standards and Practices).
22
See, e.g., Ma r k e tMo n i t o r i n gU n i t si nR e g lT r a n s m ission Orgs. And Indep. Sys. Operators, Policy Statement on Market Monitoring Units, 1 1 1 F E R C 6 1 , 2 6 7 , a t P1 ( 2 0 0 5 ) ( MMU P o l i c y S t a t e m e n t ) .
23
See, e.g., Market Behavior Rules Order, 105 FERC 61,218, at P 182; California Indep. Sys. Operator Corp., 106 FERC 61,179, o r d e r o n r e h g , 107 FERC 61,118 (2004). In addition to o b j e c t i v e l yi d e n t i f i a b l eb e h a v i o r , [ i ] f , i nt h ec o u r s eo f m o n i t o r i n gp a r t i c i p a n t b e h a v i o r , t h eMMU finds that an action by a market participant may require investigation and evaluation, or may be a potential violation of a market rule contained in an ISO/RTO-filed tariff, or may be a violation of the Ma r k e t B e h a v i o r R u l e s , t h eMMU s h o u l dn o t i f y[ F E R C ] . MMU P o l i c yS t a t e m e n t , 1 1 1F E R C 61,267 at P 6; see also Market Behavior Rules Order, 105 FERC 61,218 at P 184.
25 26
24
See, e.g., MMU Policy Statement, 111 FERC 61,267 at P 5.
Section 65.3 of the EMT generally provides for "Sanctions" for violations of the EMT. Section6 5 . 3 . 1p r o v i d e st h a tt h eMMU mustrefer to FERC any detected violations of tariff provisions barring physical withholding of generation or transmission or uneconomic production.
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OATT or PJM market rules, or (c) action by FERC and/or one or more state commissions.27 The MMU also may: Engage in discussions to bring issues to the attention of market participants and attempt to informally resolve compliance or other issues with market participants. Recommend to the appropriate entity modification to the OATT or other agreements. Through a demand letter, request a market participant to discontinue actions that the MMU believes violate the OATT or other agreements. The MMU must provide such demand letters to the relevant government agencies (subject to the protection of confidential, proprietary, and commercially sensitive information). If unable to achieve sufficient corrective action on matters through informal discussions or a demand letter, bring matters to the attention of and make appropriate recommendations to RTO committees or the board. With the approval of the RTO board, file reports or complaints with government agencies or make other appropriate regulatory filings to address design flaws, structural problems, compliance, market power, or other issues.28 The MMU primarily relies on data and information that is gathered in PJM s normal course of business, as well as publicly available data and information. 29 However, if the MMU determines that it needs additional information, it may request the entities possessing such information to provide it on a voluntary basis. 30 The recipient of the information 31 request must provide the MMU with all information that is reasonably requested. If an information request recipient does not provide such information, the MMU may initiate regulatory or judicial proceedings to compel production.32
27 28 29 30 31 32
See PJM OATT at 448. See id. at 448-49. See id. at 450. See id. at 451. Id. See id.
Chapter 18 Energy Regulation by the Commodity Futures Trading Commission

DAVID J. HILL PHILIP MCBRIDE JOHNSON A l t h o u g ht h ef o c u so f t h i sH a n d b o o ki so nt h eF e d e r a l P o w e rA c t ( F P A )a n d F e d e r a l E n e r g y R e g u l a t o r y C o m m i s s i o n ( F E R C ) r e g u l a t i o n s , e n e r g y m a r k e t e r s a n d traders 1 must take careful note of the Commodity Exchange Act ( C E A ) and the agency that e n f o r c e s t h i s s t a t u t e , t h eC o m m o d i t yF u t u r e s T r a d i n gC o m m i s s i o n( C F T C ) .S t a r t i n gi n 2002, the CFTC has aggressively asserted its jurisdiction to enforce the CEA with respect to the trading and price reporting practices of power and natural gas marketers. Since that time, twenty energy companies have paid a total of nearly $300 million to settle charges brought by the CFTC. Individuals also have been charged with civil violations of the statute. The Commodity Exchange Act also provides for criminal prosecution of individuals and for private rights of action by third parties. No compliance program for power trading is complete without developing a working familiar i t yw i t ht h eC F T C sj u r i s d i c t i o na n d enforcement priorities as well as a focused plan to address these matters. That program can a n ds h o u l db ed e v e l o p e di nc o n j u n c t i o nw i t ht h ep r o g r a mt oa d d r e s sF E R C sMa r k e t Behavior Rules, because both agencies focus on similar types of conduct and because utilities and individuals are subject to, and can be prosecuted under, both the CEA and the FPA. I. CFTC JURISDICTION OVER ENERGY TRANSACTIONS
Under the CEA, t h e C F T Cr e g u l a t e s c o m m o d i t i e s , i n c l u d i n gc e r t a i nf a r mp r oducts i d e n t i f i e db yn a m eb u t a l s o a l l o t h e r g o o d s a n da r t i c l e s . . . a n da l l s e r v i c e s , r i g h t s , a n d
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Before joining Skadden in 2001, Mr. Hill served as a trial attorney in the Bureau of Competition in the Federal Trade Commission and was a partner in another Washington, D.C. law firm. He has represented electric utilities and marketers in a wide variety of litigated and related matters before FERC, as well as in proceedings before the CFTC. He also has represented both utilities and natural gas companies in complex contract disputes, antitrust matters, and internal corporate investigations. Head of exchange-traded derivatives law practice, Skadden, Arps, Slate, Meagher & Flom LLP. Past chairman of the CFTC, founding chairman of American Bar Association and International Bar Association derivatives law committees, author of Derivatives Regulation (3 vol., 4th Ed. 2004 Aspen Law & Business) in continuous use for 23 years, author of Derivatives: A Manager's Guide to the World's Most Powerful Financial Instruments (1999 McGraw-Hill), founding counsel of the National Futures Association, twice director of the Futures Industry Association, and member of five CFTC federal advisory committees.
1
7 U.S.C. 1-26 (2004).
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2 i n t e r e s t s i n w h i c h c o n t r a c t s f o r f u t u r e d e l i v e r y a r e p r e s e n t l y o r i n t h e f u t u r e d e a l t i n . Thus, a commodity may include a service or other intangible. Electric power is the subject of 3 f u t u r e s t r a d i n g a n d t h e r e f o r e f a l l s p l a i n l y w i t h i n t h e s t a t u t e s d e f i n i t i o n .
T h e C F T C r e g u l a t e s c e r t a i n c o m m o d i t i e s m a r k e t s a n dt r a d e r s d i r e c t l y , i.e., similar to the way FERC has extensive regulations and other rules with which utilities and natural gas companies must comply. With respect to most power and natural gas trading practices, however, the agency relies on two CEA provisions, as interpreted by the CFTC and the courts, as the basis for its enforcement efforts. These include section 4c, which prohibits 4 w a s h s a l e s o r r o u n d -t r i p t r a d i n g , and section 9(a), which gives the CFTC jurisdiction to prosecute alleged price manipulation, even when transactions do not involve futures or options.5 A. SECTION 4C WASH SALES
Although the techniques used to neutralize transactions and to avoid losses and gains can vary and be quite complex, se c t i o n4 co f t h eC E Ap r o h i b i t s w a s h o r r o u n d -t r i p transactions in which the same parties agree to buy from the other and, at or about the same time, agree to sell to the other, the same amount of the same commodity at the same price for completion at the same time and place.6 Specifically, section 4c makes it unlawful for any p e r s o n t oo f f e r t oe n t e r i n t o , e n t e r i n t o , o rc o n f i r mt h eexecution of a transaction . . . involving the purchase or sale of any commodity for future delivery (or any option on such a transaction or option on a commodity) if the transaction . . . (A)(i) is [] of the character of, or is commonly known to the trade a s , a w a s hs a l e o r a c c o m m o d a t i o nt r a d e ; or (ii) is a fictitious sale; or (B) is used to cause any price to be reported, registered, or recorded that is 7 n o t a t r u e a n d b o n a f i d e p r i c e . Although the text of section 4c limits its application to futures and options, CFTC enforcement staff has taken a broader view in investigations involving electric power physical trades. In two matters ultimately resolved by administrative settlements, the CFTC charged that physical power wash trades violated section 4c. 8 T h eC F T Cd e f i n e da w a s h
2 3 4 5 6
7 U.S.C. 1a(4). As discussed in Chapter 10, FERC does not regulate energy futures trading. See 7 U.S.C. 6c(a). See id. 13(a)(1)-(5).
Absent default by one of the parties, these obligations cancel out each other as an economic matter. Wash sales or round-trip trades may be conducted for various reasons, including to create an inflated idea of the size of the c o m p a n y s a c t u a l b u s i n e s s , t o i m p r e s s s u p e r i o r s o r a c c e l e r a t e advancement within the company, and to claim bragging rights with rival traders.
7 8
7 U.S.C. 6c(a)(1)-(2).
See In re: BP Energy Co., CFTC Docket No. 05-2, Order Instituting Proceedings Pursuant to Section 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions (Nov. 4, 2004), available at www.cftc.gov/files/enf/04orders/enf-bpenergyorder.pdf; In re: Reliant Energy Servs., Inc., CFTC Docket No. 04-06, Order Instituting Proceedings Pursuant to Section 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing
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s a l e p r o h i b i t e db y se c t i o n4 ca s at r a n s a c t i o ni nw h i c ht h et r a d e sa r ei n t e n t i o n a l l y undertaken for the purpose of giving the appearance that the trades have been executed, without positions being taken in the market or any a c t u a l c h a n g ei nt h ea c c o u n t h o l d e r s 9 m a r k e t p o s i t i o n . I nb o t ho r d e r s , t h e C F T Cs t a t e dt h a t w a s hs a l e s a r e g r a v e v i o l a t i o n s , e v e n i n t h e a b s e n c e o f c u s t o m e r h a r mo r a p p r e c i a b l e m a r k e t e f f e c t , b e c a u s e t h e y u n d e r m i n e 10 confidence in the market mechanism t h a t u n d e r l i e s p r i c e d i s c o v e r y . And the CFTC also t o o k t h e p o s i t i o n t h a t , t oe s t a b l i s hi t s w a s hsales case, the Commission need not show that 11 t h e s u b j e c t t r a d e s w e r e e x e c u t e d w i t h a n i n t e n t t o m a n i p u l a t e o r a f f e c t m a r k e t p r i c e s . B. SECTION 9(A) PRICE MANIPULATION AND FALSE REPORTING
Section 9(a) of the CEA12 prohibits the manipulation of commodity prices or the reporting of false information that may affect commodity prices even when transactions do not involve futures or options. Such manipulation incl u d e s t h e c o m m u n i c a t i o n [ o f ] f a l s e o r misleading or knowingly inaccurate reports concerning . . . market information or conditions 13 t h a t a f f e c t o r t e n dt oa f f e c t t h e p r i c e o f a n yc o m m o d i t yi ni n t e r s t a t e c o m m e r c e . That is, any actual or attempted manipulation of the price of a commodity in any type of transaction in interstate commerce including physical and forward energy trades violates the CEA. Such violations are subject to both criminal and civil sanctions which can expose companies to millions of dollars in criminal fines and civil penalties that are increased by Congress from time to time.14
Remedial Sanctions (Nov. enfreliantenergy_order.pdf.

9
25,
2003),
available
at
www.cftc.gov/files/enf/03orders/
In re: BP Energy Co. at 3 (quoting In re Piasio, [1999-2000 Transfer Binder] Comm. Fut. L. Rep. (CCH) 28,276, at 50,868-88 (2000)); see also T h e C F T C s G l o s s a r y : AG u i d e T o T h e L a n g u a g e O f T h e F u t u r e s I n d u s t r y a t w w w . c f t c . g o v / o p a / g l o s s a r y / o p a g l o s s a r y _ a . h t m . In re: BP Energy Co. at 3-4 (quoting In re Piasio, [1999-2000 Transfer Binder] Comm. Fut. L. Rep. (CCH) 28,276 at 50,868-88 (2000)); In re: Reliant Energy Servs., Inc. at 6. See, e.g., In re: BP Energy Co. at 4 n.4 ( I t is not an element of proof of wash sales that t h e C o m m i s s i o ns h o ws u c ht r a d e s w e r ee x e c u t e df o r a ni l l e g i t i m a t em o t i v e . T h e s t a t u t e p r o h i b i t s w a s hs a l e s [ , ] n o t w a s hs a l e se x c e p t t h o s eh a v i n gal e g i t i m a t em a r k e t p u r p o s e . ) (quoting In re Harold Collins, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) 22,982 at 31,899 (CFTC Apr. 4, 1986), r e v do no t h e r g r o u n d s s u b n o m . , Stoller v. CFTC, 834 F.2d 262 (2d Cir. 1987)). On the other hand, in 2002, the CFTC settled an administrative proceeding against Dynegy Marketing & Trade and West Coast Power LLC. See In re: Dynegy Marketing & Trade and West Coast Power LLC, CFTC Docket No. 03-03, Order Instituting Proceedings Pursuant to Section 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions (Dec. 18, 2002), available at www.cftc.gov/files/enf/02orders/enfdynegy-order.pdf. Although these parties had p u b l i c l y a d m i t t e d e n g a g i n g i n w a s h t r a d e s , t h e C F T C s c o n s e n t o r d e r , f o r r e a s o n s n o t e x p l a i n e d i n t h e order, did not charge them with wash trading violations.
11 12 13 14 10
7 U.S.C. 13(a). Id. 13(a)(2).
The base amount of civil penalty per violation as declared in the CEA is adjusted from time to time for inflation. See 17 C.F.R. 143.8.
288
The CFTC stated in one recent order: T h et e s t f o r a t t e m p t e dm a n i p u l a t i o na n d manipulation is a flexible one. . . . [T]he means of manipulation are limited only by the ingenuity of man; thus, the test of manipulation must largely be a practical one if the purposes of the Commodity Exchange Act are to be accomplished. The aim must be therefore to discover whether conduct has been intentionally engaged in which has resulted 15 i na p r i c e w h i c h d o e s n o t r e f l e c t b a s i c f o r c e s o f s u p p l y a n dd e m a n d . The CFTC has held that, in order to prove a violation of section 9, there must be proof of specific intent or purposeful conduct.16 II. CEA ENFORCEMENT PROCEEDINGS AND REMEDIES
Alleged violations of the CEA may be enforced through administrative action by the CFTC itself, through civil suits for damages or injunctive relief filed by the CFTC in federal district court, through the criminal prosecution of individuals or corporate entities referred by the CFTC to the Department of Justice, and also through private civil suits. Under section 2 of the Act, the acts or omissions of individuals within the scope of their employment are attributable to the corporation or other legal entity. A. ADMINISTRATIVE PROCEEDINGS AND REMEDIES The CFTC may institute administrative proceedings within the agency itself, to be tried before an administrative law judge, subject to appeal to a panel of all commissioners and thereafter normally to a U.S. Court of Appeals. The burden of proof in an administrative p r o c e e d i n gi st h e w e i g h to ft h ee v i d e n c e . C F T Cc i v i ls a n c t i o n si na d m i n i s t r a t i v e proceedings include cease-and-desist orders, suspension or revocation of any CFTC registration, prohibition against using the CFTC-regulated markets, civil penalties per v i o l a t i o n o f u pt o$ 1 3 0 , 0 0 0( a na m o u n t p e r i o d i c a l l ya d j u s t e df o r i n f l a t i o n ) o r t r i p l ea n y monetary gain if higher, disgorgement, and restitution to customers. Starting in 2002, the CFTC began conducting a series of investigations involving natural gas and power marketers and traders.17 Through September 2005, the CFTC has
In re: DiPlacido, CFTC Docket No. 01-23, Order Making Findings and Imposing Remedial Sanctions as to Respondent Kristufek at 8 (Sept. 12, 2002) (internal punctuation omitted), available at www.cftc.gov/files/enf/02orders/enfavista-kristufek-order.pdf (quoting Cargill v. Hardin, 452 F.2d 1154, 1163 (8th Cir. 1971), cert. denied, 406 U.S. 932 (1972)). In DiPlacido, the respondent was charged with manipulation of the settlement prices of the Palo Verde and CaliforniaOregon-Border electricity futures contracts traded on the New York Mercantile Exchange during the period April through August 1998. S e eI nr eI n d i a n aF a r mB u r e a uC o o p . A s s n , Comm. Fut. L. Rep. [1982-84 Transfer Binder] (CCH) 21,796, at 27,282-83 (Dec. 17, 1982). This case, which is frequently cited in CFTC orders, held that, in order to prove the intent element of manipulation or attempted manipulation u n d e r s e c t i o n9 ( c ) , i t m u s t b e p r o v e nt h a t t h e a c c u s e da c t e d( o r f a i l e dt oa c t ) w i t ht h e p u r p o s e o r conscious object of causing or effecting a price or price trend in the market that did not reflect the legitimate forces of supply and demand influencing futures prices in the particular market at the time o f t h e a l l e g e d m a n i p u l a t i v e a c t i v i t y . Id.
16 15
O nMa y2 2 , 2 0 0 2 , t h e C F T Ca n n o u n c e dt h a t i t w a s e s t a b l i s h i n ga n E n r o nI n f o r m a t i o n L i n k o ni t sh o m e p a g e t oa s s ist members of the public in reporting suspicious activities or

17
289
settled 17 administrative actions relating to alleged natural gas price manipulation (one of which also involved alleged power wash trades) and one action solely relating to alleged power wash trades. In each instance, the CFTC has filed a complaint and simultaneously entered an order approving a settlement and imposing sanctions. These settled proceedings reflect the strong pressure on companies to resolve such CFTC issues short of litigation and the attendant publicity. The sanctions have included findings of fact and conclusions of law that the respondents attempted to manipulate commodity prices and/or filed false or knowingly inaccurate price reports that affect or tend to affect commodity prices; an order to cease-anddesist from further violations of the Act; a commitment to continue to cooperate in CFTC investigations; and civil penalties. The eighteen settled administrative actions are as follows:
Company Aquila Merchant Serv. BP Energy Calpine Energy Cinergy Marketing & Trading CMS Energy Coral Energy Duke Energy Dynegy El Paso Merchant Energy Enserco Entergy-Koch Trading E prime Mirant Americas Energy Marketing Oneok Energy Reliant Energy Alleged Violation Price reporting and attempted manipulation Wash trades (electric power) Price reporting Price reporting Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting Price reporting, attempted manipulation (natural gas) and wash trades (electric power) Price reporting and attempted manipulation Price reporting and attempted manipulation Price reporting and attempted manipulation Settlement Date 1/28/04 11/4/04 1/28/04 11/16/04 11/25/03 7/28/04 9/17/03 12/18/02 3/26/03 7/31/03 1/28/04 1/28/04 12/6/04 1/28/04 11/25/03 Civil Penalty (in millions) $26.5 $0.1 $1.5 $3 $16 $30 $28 $5 $20 $3 $3 $16 $12.5 $3 $18
WD Energy (Encana) Western Gas Williams Cos.
7/28/03 7/1/04 7/29/03
$20 $7 $20
transactions involving Enron or any other company that may have affected West Coast electricity or n a t u r a l g a s p r i c e s , o r a n y o t h e r c o m m o d i t y , f r o mJ a n u a r y 2 0 0 0 t h r o u g h D e c e m b e r 3 1 , 2 0 0 1 .
290
Most of these CFTC administrative settlement orders share important characteristics. First, in the orders covering both false price reporting and attempted manipulation, the CFTC chose to treat each as separate offenses under section 9(a)(2) of the CEA. Second, while the level of intent required to prove a false price reporting allegation is unclear, the CFTC e x p l i c i t l yf o u n di ne a c ho r d e r t h a t t h e p r a c t i c e w a s m o t i v a t e db y a n a t t e m p t t os k e wt h o s e in d e x e s[ f o r ]f i n a n c i a lb e n e f i t , ab e l i e ft h a t i tb e n e f i t e dt h e i rt r a d i n gp o s i t i o n so r d e r i v a t i v e s c o n t r a c t s , o r t h a t i t w a s u n d e r t a k e n i n a n e f f o r t t o b e n e f i t R e s p o n d e n t s t r a d i n g p o s i t i o n s . T h o s e f i n d i n g s w i t h r e g a r d t o false price reporting describe a deliberate purpose to affect market prices that satisfies the specific intent required to prove a price manipulation violation. Finally, while an allegation of price manipulation requires the CFTC to show that the deliberate purpose was to achieve a price in the market that would not exist under normal s u p p l y / d e m a n d p r e s s u r e s ( a n a r t i f i c i a l p r i c e ) , t h a t e l e m e n t i s n o t r e q u i r e d t o b e ( a n d c a n n o t be) established where attempted manipulation is alleged because it is not alleged that the manipulation succeeded (i.e., that the price objective was achieved). It is probably for that reason that the CFTC alleged only attempted manipulation in its orders. B. CIVIL PROCEEDINGS AND REMEDIES
The CFTC also may institute, in its own name, a civil action in a federal district court to seek civil penalties or enjoin alleged violations of the CEA.18 The CFTC normally reserves injunctive actions for situations where immediate judicial intervention is desired. The CFTC has brought a number of civil actions against energy companies and traders in federal district court. The first complaint, filed March 12, 2003, charged Enron and one of its natural gas trading managers with market manipulation and false price reporting. As part of the settlement, which was approved by the bankruptcy court, Enron agreed to pay a civil penalty of $35 million. The individual trading manager subsequently settled with the CFTC, agreeing to pay a $300,000 civil penalty.19 On September 30, 2003, the CFTC brought a civil suit in federal district court a l l e g i n gt h a t A m e r i c a nE l e c t r i cP o w e r C o m p a n ya n dA E PE n e r g yS e r v i c e s , I n c . ( A E P ) engaged in false reporting of natural gas transactions and attempted market manipulation. In January 2005, AEP settled this proceeding, paying $30 million in civil penalties. AEP also settled related CEA criminal charges brought by the Department of Justice for an additional $30 million in penalties.20
18 19
7 U.S.C. 6c.
United States Commodity Futures Trading Comm'n v. Enron Corp. , No. H-03-909, Consent Order or Permanent Injunction and Other Relief Against Defendant Enron Corp. (S.D. Tex. May 28, 2004), available at www.cftc.gov/files/enf/04orders/enfharmonconsentorder.pdf; United States Commodity Futures Trading Comm'n v. Hunter Shively, No. H-03-909, Consent Order or Permanent Injunction and Other Relief Against Defendant Hunter Shively (S.D. Tex. Jul. 16, 2004); U.S. Commodity Futures Trading Comm'n, Release No. 4960-04 (Jul. 19, 2004), available at www.cftc.gov/opa/enf04/opa4960-04.htm. See U.S. Commodity Futures Trading Comm'n v. American Elec. Power Co., Inc., No. 2:03-cv-891, Final Judgment and Consent Order (E.D. Ohio Jan. 26, 2005); U.S. Commodity Futures
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In July 2004, the CFTC brought a civil action for injunctive relief in federal district court against NRG Energy, Inc ( NRG ). The complaint charged that NRG gas traders transmitted false and misleading reports to the trade press. This proceeding has not been resolved as of this printing. On February 1, 2005, the CFTC announced that it had brought five civil actions for injunctive relief and civil monetary penalties in federal district court against a total of 15 natural gas energy traders and one company formed by several of these traders, for false reporting to the trade press and attempted market manipulation. Again, this proceeding has not been resolved as of this printing. C. CRIMINAL PROCEEDINGS
Any criminal prosecution under section 9 of the CEA would be undertaken by the D e p a r t m e n t o f J u s t i c e t h r o u g h a U . S . A t t o r n e y s o f f i c e i n a n a p p r o p r i a t e v e n u e .T h e r e h ave 21 been a number of indictments of energy traders for false price reporting. The burden of 22 p r o o f , a s i n a l l c r i m i n a l c a s e s , i s b e y o n da r e a s o n a b l e d o u b t . The criminal sanctions are set forth in section 9(a), which provides that violations shall be felonies punishable by a fine of not more than $1,000,000 (or $500,000 in the case of a person who is an individual) or imprisonment for not more than five years, or both, together with the costs of prosecution. Congress is free to raise these criminal penalties and has done so from time to time. D. PRIVATE CIVIL ACTIONS
Finally, Section 22 of the CEA provides for a private right of action for violations of t h e A c t i f t h e v i o l a t i o n [ i n v o l v i n ga c o n t r a c t o f s a l e o f a n y c o m m o d i t yf o r f u t u r e d e l i v e r y ] constitutes a manipulation of the price of any such contract or the price of the commodity
T r a d i n gC o m m n, Release No. 5041-05 (Jan. 26, 2005), available at www.cftc.gov/opa/enf05/ opa5041-05.htm. See, e.g., United States v. Todd Geiger, CR H-02-712 (S.D. Tex. (Houston Div.) Dec. 2, 2002); United States v. Michelle Valencia, CR H-03-0024 (S.D. Tex. (Houston Div.) Jan. 22, 2003); United States v. Greg Singleton and Michelle Valencia, Crim. No. 04-514 (S.D. Tex. (Houston Div.) Nov. 17, 2004). In December 2003, Mr. Geiger pled guilty to one count of false price reporting. B o t hMs . V a l e n c i a si n d i v i d u a l c a s ea n dt h ej o i n t c a s ea g a i n s t Mr . S i n g l e t o na n dMs . V a l e n cia remain pending. See also In re: Brion Scott McKenna, CFTC Docket No. SD05-03 (May 5, 2005) (noting that respondent had previously pleaded guilty to the felony crime of manipulation in violation of section 9(a)(2) of the CEA). In August 2003, a federal district court in Houston ruled in the Geiger and Valencia cases that CEA section 9(a)(2) violates the First Amendment to the U.S. Constitution in that, by failing to r e q u i r e a s a n e l e m e n t o f p r o o f t h a t f a l s e o r m i s l e a d i n g i n f o r m a t i o n w a s k n o w n t o be such by the a c c u s e di n d i v i d u a l s , t h e p r o h i b i t i o n i s o v e r b r o a d a n d t h e r e f o r e a n u n c o n s t i t u t i o n a l i n f r i n g e m e n t o f free speech. In December 2004, however, the United States Court of Appeals for the Fifth Circuit reversed, holding that, although a natural reading of section 9(a)(2) was consistent with the district c o u r t s r u l i n g , U . S . S u p r e m e C o u r t p r e c e d e n t m a n d a t e dt h a t t h e s t a t u t e b e r e a dn a r r o w l yt op r e v e n t the conclusion that the reporting prong of the statute was overbroad and criminalized innocent conduct. See United States v. Valencia, 394 F.3d 352 (5th Cir. 2004).
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23 u n d e r l y i n g s u c h c o n t r a c t . For example, in early 2004, plaintiffs brought two class actions against numerous companies, alleging manipulation of gas futures markets by falsely reporting data on natural gas trades in the physical market.24 Although only actual (single) damages can be recovered in an action based entirely on section 22, courts have held that such a claim can be combined in manipulation cases with allegations under the federal laws, e.g., antitrust laws, where treble damages may be assessed. 25
E.
CFTC/FERC COORDINATION
On October 12, 2005, the CFTC and FERC entered into a Memorandum of Understanding ( MOU ) Regarding Information Sharing and Treatment of Proprietary Trading and Other Information.26 It is public knowledge that these two agencies (along with v a r i o u s U . S . A t t o r n e y s offices) have shared information in the past with respect to power and natural gas trading investigations.27 This new MOU formalizes the information sharing process. As a result, information held by either agency may be shared with the other, so compliance officers should be aware that data sent to FERC or to the CFTC is, in effect, sent to both.28 Under the new MOU: FERC shall direct in writing to the CFTC any and all requests for futures and options trading data or other information.
23 24 25 26
7 U.S.C. 25(a). See In re: Natural Gas Commodities Litigation, 337 F.Supp. 2d 498 (S.D.N.Y. 2004). Stobl v. New York Mercantile Exch., 768 F.2d 22 (2d Cir. 1985).
Sections 316 and 1281 of the Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 594 (2005) directed these agencies to conclude a memorandum of understanding, within 180 days of s t a t u t e se n a c t m e n t o nA u g u s t 8 , 2 0 0 5 , t oe n s u r et h a t i n f o r m a t i o nr e q u e s t st om a r kets within the respective jurisdiction of each agency are properly coordinated to minimize duplicative information requests and to address the treatment of proprietary trading information. See, e.g., Federal Energy Regulatory Commission Staff, Final Report On Price Manipulation In Western Markets Fact-Finding Investigation Of Potential Manipulation Of Electric And Natural Gas Prices, Docket No. PA02-2-000, at III-53 (March 2003) (referring to pending criminal cases against individual gas traders and stat i n gt h a t S t a f f h a s p r o v i d e dt h eU n i t e dS t a t e s A t t o r n e y s O f f i c e sa n yr e l e v a n t i n f o r m a t i o nr e g a r d i n gt h e s ec a s e sa n dw i l l c o n t i n u et od os o . I n addition, Staff has provided other government agencies (including the CFTC and the SEC) with any relevant information regarding their investigations of index price reporting and will continue to do s o . ) ( F i n a l R e p o r t o n P r i c e Ma n i p u l a t i o n ) .
28 27
In announcing the MOU on October 12, 2005, FERC Chairman Kelliher stated:
The fact that we have this agreement with the CFTC four months ahead of schedule is a clear sign of the enhanced cooperation and coordination between our two agencies. This means the agreement is in place well before the winter heating season, when already stressed energy prices will require vigilance. This agreement will contribute to better coordination of enforcement.
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Any futures and options trading data or other information furnished by the CFTC to FERC shall be kept confidential and non-public, and shall not be disclosed or made available by FERC to any other person except in an action or proceeding under the laws of the United States to which FERC, the CFTC, or the United States is a party. FERC may disclose to other persons the information furnished by the CFTC only in certain administrative or enforcement proceedings. 29 In the event the CFTC seeks data or information which may be in the possession of FERC, the CFTC shall direct in writing a request for such information to FERC. Any data or information obtained by FERC pursuant to the confidentiality provisions of 18 C.F.R. Part 1b or any other FERC confidentiality regulation, and furnished by FERC to the CFTC, shall be kept confidential and non-public, and shall not be disclosed or made available by the CFTC to any other person except in an action or proceeding under the laws of the United States to which the CFTC or the United States is a party. The CFTC and FERC will confer on coordinating procedures relating to the disclosure of information so as to conform to third-party notice requirements of their respective regulations. They agree to avoid duplicative information requests to the extent possible, and to coordinate on a regular basis oversight, investigative, and enforcement activities of mutual interest.30 And they agree that the MOU does not in any way interfere with, proscribe, or adversely affect the ability or authority of FERC or the CFTC to obtain any information directly from entities subject to their powers to obtain information. As noted, this MOU formalizes what have been on-going cooperative efforts between these agencies in numerous investigations. This new arrangement, however, should serve as a reminder to utilities and marketers that federal regulators have powerful tools at their disposal to investigate practices that may constitute violations of the CEA, the FPA, and/or the Natural Gas Act and that investigations initiated by one agency may lead to investigations by the other. Moreover, as noted above, utilities and individuals be may the subjects of investigations and enforcement proceedings carried out by either or both agencies. III. SIGNIFICANT UNCERTAINTIES IN INTERPRETATION Because the CFTC is enforcing broad statutory provisions when it charges a marketer or trader with wash trades or market manipulation, energy companies cannot rely on specific
A r g u a b l y ,t h i sp r o v i s i o nc o n s t r a i n sF E R C sd i s s e m i n a t i o no fd a t aa n di n f o r m a t i o n obtained from the CFTC even more severely than does the Freedom of Information Act. 5 U.S.C. 552. This is because it appears to apply to all data furnished by the CFTC, even if it would not otherwise be considered confidential and non-public.
29
To facilitate this coordination, the respective oversight and enforcement staffs of the FERC and CFTC are authorized to share information concerning ongoing oversight, investigative, and enforcement activities to determine whether and when they have a mutual interest in matters.
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rules or regulations to guide their conduct or to assess their exposure risks. The best g u i d a n c ec a nb ef o u n di nt h ea g e n c y sc o m p l a i n t sa n ds e t t l e m e n to r d e r sa n di nc o u r t decisions. A. INTENT OF WASH TRADES
As noted above, the CFTC has taken the position in the two settlements involving power wash trades (BP Energy and Reliant)t h a t t oe s t a b l i s hi t sw a s hsales case, the Commission need not show that the subject trades were executed with an intent to manipulate 31 o r a f f e c t m a r k e t p r i c e s . FERC staff has gone even further and suggested that all wash trades are associated with price manipulation because they can skew commodity prices, even when round-trip trades occur at prevailing market prices.32 Thus, compliance officers must be alert for any wash sale or round-trip trading regardless of its motivation or purpose. B. INTENT AND EFFECT OF FALSE PRICE REPORTING
Whether certain reported prices were inaccurate in that they did not correspond with the real transactions for which the trade publications requested information is empirically either demonstrable or refutable, assuming the pertinent records are available. Whether such inaccurate prices affected index prices (in an actual manipulation case) presents a more d i f f i c u l t q u e s t i o n .A b s e n t a c c e s s t ot h e t r a d e p u b l i c a t i o n s i n t e r n a l r e c o r d s , including information regarding any discretionary or judgmental factors involved, it could be difficult for the CFTC to establish this element of the offense, or for the defense to present a meaningful rebuttal.33 Whether reporting occurred with knowledge that the prices were inaccurate requires direct or circumstantial evidence that is specific to the mental state of particular individuals, such as recorded conversations or written communications that are incriminating. Even if such evidence were to exist in specific instances, it is unclear whether a court would assume
31 32
In re: BP Energy Co. at 4 n.4; In re: Reliant at 6 n.5; see also supra note 11.
See Final Report on Price Manipulation, at VII-1 2 .F E R C s r e g u l a t i o n s d e f i n en a t u r a l gas wash trades as pre-arranged offsetting trades of the same product among the same parties, which involve no economic risk and no net change in beneficial ownership. See 18 C.F.R. 284.288(a)(1) (2005). One of the principal publishers of price trading information, McGraw-Hill, has resisted on First Amendment grounds at least two attempts by the CFTC to enforce civil subpoenas for its internal natural gas price reporting documents. Recently, however, a federal district court granted the C F T C s m o t i o n t o c o m p e l c o m p l i a n c e w i t h a s u b p o e n a i n a c i v i l i n v e s t i g a t i o n o f a n u n n a m e d n a t u r a l gas trading company. In the Matter of an Application to Enforce Administrative Subpoenas of the U.S. Commodity Futures Trading Commission v. The McGraw-Hill Cos., Inc., No. 05-235 (RCL) (D.D.C.) (Oct. 4, 2005). In addition, McGraw-Hill produced documents pursuant to a federal grand jury criminal subpoena in Houston. See United States v. Phillips, No. H-04-512 (S.D. Tex. (Houston Div.)) (Sept 2, 2005). In granting in part and denying in part McGraw-H i l l s m o t i o n f o r a p r o t e c t i v e order, the court in the latter case noted the Government s r e p r e s e n t a t i o n s t h a t i t i n t e n d e dt ou s e t h e p u b l i s h e r s r e c o r d s w i t hv i r t u a l l ya l l o f i t s w i t n e s s e s t o s h o w t h a t p a r t i c u l a r f a l s e r e p o r t s a c t u a l l y a f f e c t e d i n d e x p r i c e s . Id. at 4 & n.1.
33
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a pervasive course of conduct is evidence of intent or would instead expect to receive proof of knowledge with respect to each report or price. In all cases, however, a compliance officer should be attentive to any pattern of conduct involving repeated misreporting of true prices and should make an appropriate inquiry to determine the cause. The prospect for business gain can act as motivation to misreport actual prices, as can a desire to offset what the reporting person believes to be biased and false prices reported by competitors or others. Particularly in the case of transactions that are priced and concluded based on prices as published by a particular exchange or a specific trade publication, parties may seek to skew that data by providing incorrect price data in a way that amplifies the value of one's own transactions or neutralizes a perceived effort by counterparties or competitors to achieve that aim in their own favor. A related but exculpatory element whether the false price reports might adversely affect other company business would involve comparing the potential impact of false prices on company transactions, for example, if the erroneously reported price influenced the index i na d i r e c t i o nn o t f a v o r a b l e t ot h ec o m p a n y s p o s i t i o n ; o r i f t h ee r r o n e o u s l yr e p o r t e dp r i c e was indexed to other measures (e.g., NYMEX settlement prices)34 or on company transactions bearing fixed prices that remain to be performed (e.g., long-term supply contracts). Wh e t h e r t h ei n a c c u r a t er e p o r t s a f f e c t o r t e n dt oa f f e c t c o m m o d i t yp r i c e sm a y require three steps. First, establishing whether the prices as reported could impact the decision on the index level. This should entail an exposition of the entire index development process including what data were accepted and rejected, whether prices from some sources were given greater weighting or credit than data from others, what effect the size of a reported transaction had on the calculation, the mathematical algorithm used, how much human judgment was involved, what filters existed in the calculation process to aid accuracy, etc. Second, whether the published indexes could or did affect the market value of the underlying commodity, which may require further proof of a causal relationship between the index levels and general market conditions for the commodity. Third, because the impact of the index levels on a commodity must examine their e f f e c t o n i n t e r s t a t e c o m m e r c e , i t m a yb e n e c e s s a r y f o r t h e C F T Ct os h o wm o r e
In its settlement orders, the CFTC has made findings to th e e f f e c t t h a t [ p ] a r t i c i p a n t s i n t h en a t u r a l g a sm a r k e t su s et h e s ei n d e x e st op r i c ea n ds e t t l ec o m m o d i t yt r a n s a c t i o n s a n dt h a t n a t u r a l g a s f u t u r e s t r a d e r s r e f e r t o t h e p r i c e s p u b l i s h e d b y t h e r e p o r t i n g f i r m s f o r p r i c e d i s c o v e r y a n d for assessing price ri s k s . See, e.g., In re Oneok Energy Mktg. & Trading Co., L.P., CFTC Docket No. 04-09, Order Instituting Proceedings Pursuant to Section 6(c) and 6(d) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions at 2 (Nov. 4, 2004), available at www.cftc.gov/files/enf/04orders/enfoneok-order.pdf. An allegation of effect on gas futures prices a l s o a p p e a r s i n t h e C F T C s AEP complaint. See section II.B supra.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK than an impact on a small subset of financial deals among energy firms but rather on the aggregate interstate market.35
C.
IDENTIFYING VIOLATIONS AND SETTING PENALTIES
In civil actions, there is no clear line of authority on what constitutes a single or 36 s e p a r a t e v i o l a t i o n o f t h e C E A . The CFTC has stated that the amount of an appropriate civil money penalty i s o n e t h a t d e t e r s f u t u r e v i o l a t i o n s b y m a k i n g i t b e n e ficial financially to comply with the requirements of the Act and Commission regulations rather than risk 37 v i o l a t i o n s . The only clear CFTC policy regarding calculation of civil penalties occurs in cases where the respondent realized a quantifiable gain or victims suffered a quantifiable loss. Under such circumstances, the penalty amount consists approximately of that sum plus a deterrence premium. In its 2003 complaint against AEP, the CFTC alleged that the defendants reported to certain McGraw-Hill trade publications approximately 2,800 trades that were false, misleading or knowingly inaccurate38 and that trading profits during the period (which presumably included legitimate transactions) were roughly $63.5 million. Under the civil penalty/triple moneta r y g a i n s t a n d a r d s i n e f f e c t d u r i n g t h e p e r i o d i n q u e s t i o n , t h e d e f e n d a n t s potential exposure if all allegations were proven and each misreported trade were viewed as a separate violation could have been civil penalties of $336 million or disgorged profits of $190 million. As noted, AEP settled the CFTC case for $30 million. CFTC policy in the case of activities that cannot be shown to have generated gain or inflicted loss is less clear. In one recent case, where speculative position limits were breached by holding 43 pork belly futures contracts above the prescribed limit for a period of one day, including the acquisition of 10 contracts allegedly in violation of section 4a(e) of the CEA on that date, a civil penalty of $110,000 was assessed. The events appear to have been t r e a t e da sas i n g l e v i o l a t i o n , a st h ea m o u n t o fc i v i l p e n a l t yw a se x a c t l yt h es t a t u t o r y inflation-adjusted maximum allowed at that time for a single violation. While the holding of
On the other hand, the trade publications included indexes for prices at locations different from the delivery points for exchange-traded gas and power contracts, some of which were used only infrequently so that the indexes were based on very limited information received and false data could have had a substantial impact on the calculations. When filing a case in federal court, however, the agency typically alleges that each occurrence of, for example, price misreporting, is a distinct violation. See, e.g., CFTC v. Richmond, Complaint for Injunctive and other Equitable Relief and Civil Monetary Penalties Under the Commodity Exchange Act at 41, No. 05-M-6 6 8( D . C o l o . ) ( f i l e dA p r . 1 2 , 2 0 0 5 ) ( E a c ho c c a s i o n upon which defendant delivered, or caused to be delivered, for transmission through the mails or interstate commerce . . . false or misleading or knowingly inaccurate transaction information concerning natural gas transactions is alleged herein as a separate and distinct violation of section 9 ( a ) ( 2 ) o f t h e A c t . ) . In the Matter of Gordon, [1992-94 Transfer Binder] Comm. Fut. L. Rep. (CCH) 25,667 (Mar. 16, 1993). The CFTC also alleged that an unestimated number of actual transactions were wrongly withheld from the trade publications, and that misreporting occurred at other publications.
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each of the 43 excess contracts might have been deemed to be a separate violation, and the accumulation of 10 additional contracts while already above the limit might have been viewed as additional violations, the calculation selected was the most conservative one. Similarly, the CFTC has stated that, in cases where gain to the violator or loss to victims is difficult to quantify but the activity affected the markets, the dominant consideration in setting civil penalties is to achieve a deterrent effect: The methods used to determine the gravity of solicitation fraud offenses [gain or loss] are not readily transferable to trade practice cases where, as here, financial harm to customers is difficult to measure and the violative conduct has the potential for threatening the integrity of the markets and the confidence of all who rely on them for risk shifting and price discovery. . . . The penalties we impose on these respondents reflect and seek to deter the b e t r a y a l o f t h e p u b l i c i n t e r e s t i n h e r e n t i n t h e r e s p o n d e n t s a b u s e o f a r e g u l a t e d public market. . . . We believe that effective deterrence occurs when it is no longer worthwhile for a wrongdoer to risk engaging in acts that threaten the integrity of the markets.39 In power and natural gas markets, a false price reporting violation might be based on any of the following non-mutually exclusive bases: The overall pattern of conduct, i.e., maintaining a program of disinformation over a period of time, may constitute a single on-g o i n g v i o l a t i o n o f t h e C E A . Because section 9(a)(2) of the Act prohibits the di s s e m i n a t i o no f f a l s eo r misleading or knowingly inaccurate reports( e m p h a s i s a d d e d ) , e a c hb u n d l eo f d a t a p r o v i d e d t o a t r a d e p u b l i c a t i o n m a y b e a s e p a r a t e v i o l a t i o n . Each individual piece of data contained within a single bundle that was false, mislead i n g o r k n o w i n g l y i n a c c u r a t e m a y b e a s e p a r a t e v i o l a t i o n . Each day during which false prices remained uncorrected may be a new v i o l a t i o n i n a d d i t i o n t o t h e o r i g i n a l m i s c o n d u c t . Each correct price that was not reported could be a separate violation as well. 40
In the Matter of Mayer, [1996-98 Transfer Binder] Comm. Fut. L. Rep. (CCH) 27,259 (Feb. 3, 1998). No mention was made in the Dynegy settlement order about withholding correct prices, but a finding to that effect appears in the El Paso, WD Energy, Williams and Enserco orders. As there is no affirmative obligation under the CEA to file reports with trade publications, the CFTC appears to be relying on an act-of-omission theory that withholding true data was part of the scheme to deceive the trade publications. However, section 9a(2) is explicit that there must be a delivery of f a l s ed a t a f o rt r a n s m i s s i o nt h r o u g ht h em a i l so ri n t e r s t a t ec o m m e r c eb yt e l e g r a p h ,t e l e p h o n e ,
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Accordingly, the CFTC has very broad latitude when calculating how many v i o l a t i o n s i t w i s h e s t oc i t e a n d , b e c a u s e t h e n u m b e r o f c i t e dv i o l a t i o n s d i r e c t l ya f f e c t s t h e maximum amount of civil penalties that it may collect from offenders, the CFTC has every reason to cite as many violations as possible. IV. COMPLIANCE RECOMMENDATIONS In addition to the general training and other compliance protocols set forth in this Handbook, CFTC compliance should be focused on shaping attitudes and structuring procedures: A. WASH TRADES Audit sales activity periodically to determine: o whether recorded profits and losses are proportional to the size of the sales; where profits or losses seem low in relation to sales volumes, examine trades for wash sales; o whether there is any unusual level of activity with the same counterparties; and o whether a significant number of transactions go uncompleted on the stated performance date. Do not make booked but pending sales or purchases a significant element of compensation or promotion. B. PRICE REPORTING Do not use vulnerable price sources (i.e., sources that may be subject to manipulation by others) for trade valuation. Use prices in highly liquid, active markets. If those prices are not fully reflective of the economics at a location, size or grade of a particular trade, negotiate a fixed differential to add to/subtract from the base price (i.e., if the price at location X is typically 5 cents above or below the published exchange price, the agreement should utilize that formula). C. OVERALL STEPS Do not over-e m p h a s i z e l e a g u e t a b l e s a n d o t h e r c o m p a r a t i v e ( b r a g g i n g r i g h t s ) lists based on sales volumes or sales dollars.
w i r e l e s s o r o t h e r m e a n s o f c o m m u n i c a t i o n . 7 U . S . C . 1 3 ( a ) ( 2 ) . A s a r e s u l t , t h e C F T C s t h e o r y t h a t failure to communicate data violates the Act is subject to challenge.
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Openly discipline employees or agents who engage in this activity. Do not waver even if the misconduct has been highly profitable. Keep the trading function under the oversight and supervision of non-trading personnel. Absent compelling reason, do not assign the trading function to a remote location or make it subject to an unusual chain of command. Have, and demonstrate it openly, an aggressively enforced policy as well as a system for assessing when trading risks are excessive, not based after-the-fact on results but during the creation and maintenance of open market positions.
Chapter 19 Antitrust Enforcement

JOHN H. LYONS The Supreme Court has observed that the antitrust laws stand as the Magna Carta of free enterprise. They are as important to the preservation of economic freedom and our freeenterprise system as the Bill of Rights is to the protection of our fundamental personal 1 freedoms. The antitrust laws aim to promote consumer welfare by protecting competition, not competitors.2 Although federal and state statutes provide for extensive regulation of U.S. electric power and natural gas utilities, these laws and regulations do not exempt utilities from the antitrust laws. To the contrary, the antitrust laws apply to many aspects of the energy industry, particularly those that involve unregulated or lightly regulated competitive conduct (e.g., power trading and marketing), which are the principal but not sole focus of this chapter. In general, regulatory and antitrust principles reinforce each other. All are designed to prevent or curb the acquisition or exercise of market power i.e., profitably reducing output or quality, or increases in price. Consequently, the key to compliance is understanding the basic requirements of the antitrust statutes and recognizing the co-existence of and interplay between them and the requirements of the regulatory regimes. I. THE STATUTORY FRAMEWORK
Three principal federal antitrust statutes apply to the energy industry: the Sherman Act, the Clayton Act and the Federal Trade Commission Act. In addition, most states have enacted unfair competition statutes that parallel the federal antitrust laws, although some state laws have additional or different provisions. A. THE SHERMAN ACT
Section 1 of the Sherman Act prohibits businesses from entering into agreements, express or implied, that unreasonably restrain trade. 3 Certain agreements (called per se offenses ) are deemed to be so inherently anticompetitive that they are always illegal under
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Lyons has represented a wide range of clients in antitrust matters before the Antitrust Division of the U.S. Department of Justice, the Federal Trade Commission, state attorneys general, as well as in federal court litigation. In particular, he has advised electric utilities, independent power producers and marketers on antitrust compliance issues and represented them in antitrust investigations of mergers, acquisitions and market conduct.
1 2 3
United States v. Topco Assocs., 405 U.S. 596, 610 (1972). Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 488 (1977). 15 U.S.C. 1 (2004).
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section 1, regardless of the intent of the parties or the actual effect of the agreements.4 These include agreements between competitors to fix prices or the terms and conditions of sale (including credit terms and discounts), agreements to limit output, agreements to rig bids, agreements to allocate customers or territories, agreements not to deal with any person or persons ( group boycotts ), resale price agreements, and, in certain circumstances, agreements to sell one product conditioned on an agreement by the buyer to purchase a second, distinct product ( tying arrangements ).5 Other activities including requirements contracts, exclusive dealing contracts, and cooperative marketing activities are analyzed under a rule of reason,under which competitive intent and effect are weighed along with the business justifications for the activities to determine their legality. Section 2 of the Sherman Act prohibits a firm from unlawfully monopolizing, attempting to monopolize or conspiring to monopolize the purchase or sale of a product in a market.6 B. THE CLAYTON ACT
The Clayton Act, among other things, prohibits a seller from conditioning the sale or lease of a product on the buyer s agreement not to deal in the products of a competitor where the effect may be to lessen competition or to tend to create a monopoly.7 The Clayton Act is also the primary federal statute governing the legality of mergers, stock acquisitions, asset acquisitions, and other corporate combinations. 8 In addition, the Clayton Act prohibits a person serving simultaneously as a director or board-elected or board-appointed officer of two or more competing corporations. 9 (The Federal Power Act has its own interlocking
Broadcast Music, Inc. v. CBS, 441 U.S. 1, 19-20 (1979); Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 50 (1977); Northern Pac. Ry. v. United States, 356 U.S. 1, 5 (1958). United States v. Trenton Potteries Co., 273 U.S. 392, 396-401 (1927) (direct price-fixing agreements); Business Elecs. Corp. v. Sharp Elecs. Corp., 485 U.S. 717, 735-36 (1988) (minimum resale price maintenance agreements); Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2 (1984) (tying agreements).
6 7 8 5
15 U.S.C. 2. Id. 14.
Section 7 of the Clayton Act prohibits stock or asset acquisitions that may substantially lessen competition, or tend to create a monopoly, in any properly defined market. Id. 18. The HartScott-Rodino Antitrust Improvements Act of 1976 amended the Clayton Act to require parties to a stock or asset transaction meeting certain size thresholds to notify and submit certain information about the transaction to the Federal Trade Commission and the Department of Justice, and to observe a waiting period before closing that allows one of the agencies to investigate the competitive i m p l i c a t i o n s o f t h e t r a n s a c t i o n u n d e r t h e s u b s t a n t i a l l e s s e n i n go f c o m p e t i t i o n s t a n d a r d o f s e c t i o n 7 . Id. 18a.
9
Id. 19.
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directorate provision, discussed in Chapter 12.) Moreover, Clayton Act provisions enable private civil actions to recover treble damages or to obtain injunctive relief. 10 C. THE FEDERAL TRADE COMMISSION ACT
Section 5 of the Federal Trade Commission Act ( F T CA c t ) prohibits all unfair 11 methods of competition and unfair or deceptive acts or practices. The FTC Act has been interpreted to cover Sherman Act violations, conduct that falls short of, but might ultimately lead to, Sherman Act violations, and anticompetitive practices similar to those prohibited by the Clayton Act.12 In addition, the FTC Act prohibits all forms of deceptive or misleading advertising and trade practices, such as disparaging a competitor s product or service offerings, harassing a customer, and stealing trade secrets or customers lists.13 D. PENALTIES
The penalties for violating the antitrust laws are severe and can be applied to both the company and to individuals. The United States, through the Department of Justice, may prosecute Sherman Act violators as criminal felons. 14 Employees, officers, directors, or agents who authorize or participate in many types of antitrust offenses (such as price fixing and bid rigging) can be imprisoned for up to ten years and can be fined, for each offense, up to the greatest of: (i) $1,000,000; (ii) twice the gross monetary loss caused to the victim(s) of the crime; or (iii) twice the gross monetary gain derived from the crime. The company also could be fined for each offense, up to the greater of: (i) $100 million; (ii) twice the gross monetary loss caused to the victim(s) of the crime; or (iii) twice the gross monetary gain derived from the crime.15
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Id. 15, 26. Id. 45.
See, e.g., FTC v. Motion Picture Adver. Serv. Co., 344 U.S. 392, 394-95 (1953); FTC v. Cement Inst., 333 U.S. 683, 694 (1948); Fashion Originators Guild v. FTC, 312 U.S. 457, 463-64 (1941); American News Co. v. FTC, 300 F.2d 104, 108 (2d Cir. 1962). See, e.g., FTC v. Colgate-Palmolive Co., 380 U.S. 374, 387 (1965); Jay Norris Corp., 91 F.T.C. 751 (1978), enforced as modified, 598 F.2d 1244 (2d Cir. 1979); Borden, Inc., 92 F.T.C. 669 (1978), vacated and remanded for entry of consent judgment, 461 U.S. 940 (1983); Portwood v. FTC, 418 F.2d 419 (10th Cir. 1969). The FTC summarized the law of deception and its enforcement approach in a still-operative policy statement. Federal Trade Commission Policy Statement on Deception (1983), reprinted in 4 Trade Reg. Rep. (CCH) 13, 205, and appended to Cliffdale Assocs., Inc., 103 F.T.C. 110, 174 (1984). When the Sherman Act was enacted in 1890, sections 1, 2 and 3 were criminal provisions only. See 15 U.S.C. 1-3. Civil actions based on Sherman Act violations were not possible until passage of the Clayton Act in 1916. Section 215 of the Antitrust Criminal Penalty Enhancements and Reform Act of 2004 amended sections 1, 2 and 3 of the Sherman Act to significantly increase the maximum prison term from 36 months to 10 years, and the maximum fine for an individual from $350,000 to $1 million for each offense. The statute also raised the maximum fine for a corporation from $10 million to $100 million per offense.
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In addition, private parties, the federal government, and state attorneys general acting on the state s behalf and/or on behalf of persons who are residents in the state ( parens patriae ) can bring civil suits and recover three times their actual damages, plus court costs and, other than in suits by the federal government, attorneysfees. 16 Treble damage judgments can quickly amount to hundreds of millions of dollars. Furthermore, government prosecutors today routinely add wire fraud and mail fraud counts to antitrust charges, which may result in additional prison sentences and/or fines.17 Government prosecutors also can add racketeeringcounts, which can result in longer prison sentences and/or larger fines. Government lawyers also vigorously prosecute cases of perjury and false declarations, which are punishable by monetary fines and/or imprisonment. Remember, even if they are ultimately shown to be meritless, antitrust suits are expensive and time consuming to defend, and disruptive to personal lives and business operations. II. A. SPECIFIC POTENTIAL COMPLIANCE ISSUES
RELATIONS WITH COMPETITORS
Electric power industry deregulation and restructuring have led to changes in business activities that require industry participants to be more aware of antitrust risks than ever before. The greatest potential for antitrust problems arises from relations with competitors. Any type of agreement, understanding, or arrangement between competitors, whether written or oral, formal or informal, express or implied, that limits competition is subject to antitrust scrutiny under section 1 of the Sherman Act. To establish a section 1 violation, the government or private plaintiff must prove: (1) the fact of a contract, combination or conspiracy (i.e., an agreement) between two or more independent actors that (2) unreasonably restrains trade and (3) affects interstate or foreign commerce.18 The Supreme C o u r t h a s d e f i n e d a g r e e m e n t u n d e r se c t i o n1a s a unity of purpose or a common design 19 and understanding, or a meeting of minds in an unlawful arrangement. In addition, a conspiratorial agreement may be inferred by a jury from wholly circumstantial evidence.20
15 U.S.C. 15(c), 15a, 15c. The statute of limitations for civil antitrust actions is four years after the cause of action accrued. Id. 15b. 18 U.S.C. 1341-43. See United States v. Ames Sintering Co., 927 F.2d 232 (6th Cir. 1990) (per curiam) (affirming convictions for wire fraud and attempted wire fraud); United States v. MMR Corp., 907 F. 2d 489 (5th Cir. 1990) (affirming mail fraud conviction). E.g., Maric v. St. Agnes Hosp. Corp., 65 F.3d 310, 313 (2d Cir. 1995). In addition, a private plain t i f f m u s t p r o v ei t h a ss u f f e r e d a n t i t r u s t i n j u r y , i.e., injury caused by a reduction in competition rather than an increase in competition. See Brunswick Corp. v. Pueblo Bow-O-Mat, Inc., 429 U.S. 477, 488 (1977). Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752, 771 (1984) (quoting American Tobacco Co. v. United States, 328 U.S. 781, 810 (1946)). Apex Oil Co. v. DiMauro, 822 F.2d 246, 253 (2d Cir. 1987); see Monsanto Co. v. SprayRite Serv. Corp., 465 U.S. 752, 765-66 (1984).
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To be clear, section 1 is not intended to prohibit or interfere with ordinary business conduct, including price discovery, associated with legitimate attempts to buy or sell products or services in the marketplace. Instead, section 1 is directed at agreements that could directly or indirectly affect the prices, output or other competitive choices or decisions of particular third parties or the market as a whole. Moreover, any attempt to reach such agreements, understandings, or arrangements may be unlawful, even if it is unsuccessful. As discussed in sections that follow, even seemingly innocent conversations between or among employees, representatives or agents of competitors could support an allegation that competitors have reached or attempted to reach an unlawful agreement. 1. Price Fixing: Agreements that Directly Affect Price Agreements or attempts to enter into agreements between or among competitors (acting as competitors and not as customers or suppliers) with respect to prices charged to third parties are illegal, regardless of whether the prices are higher or lower, reasonable or unreasonable, or whether they are identical or different.21 Such agreements would include any understanding that prices should or should not be raised or lowered, or that any price differential will be maintained or should be changed. No explanation or defense will be considered once such an agreement is entered into or even attempted.22 In particular, the advent of market-based rate authority and the development of wholesale power trading markets have necessarily been accompanied by dramatic increases in entirely legitimate interactions and exchanges of information among employees of competitors in the electric power industry. While it is perfectly lawful for energy traders to agree upon the prices at which they will engage in an actual transaction to buy and sell electricity and/or fuel, any agreement or understanding between or among traders concerning or affecting prices at which they will transact business with third parties is absolutely forbidden.23 It makes no difference whether the prices agreed upon are higher, lower, or merely stabilized. In particular, the following must be avoided: agreements with competitors on what bid or ask prices they will make for electricity and/or fuel to be purchased and/or sold to third parties or the market as a whole;
FTC v. Superior Court Trial Lawyers Ass n, 493 U.S. 411, 421-23 (1990); Arizona v. Maricopa County Med. Soc y, 457 U.S. 332, 342 (1982); United States v. Socony-Vacuum Oil Co., 310 U.S. 150, 223 (1940); United States v. Trenton Potteries Co., 273 U.S. 392, 396-401 (1927).
21
Superior Court Trial Lawyers Ass'n, 493 U.S. at 423; NCAA v. Board of Regents, 468 U.S. 85, 103-04 (1984); Ma r i c o p aC o u n t y Me d . S o c y , 457 U.S. at 347; Northern Pac. Ry. v. United States, 356 U.S. 1, 5 (1958); Socony-Vacuum Oil Co., 310 U.S. at 221-22; Drury Inn-Colorado Springs v. Olive Co., 878 F.2d 340, 342-43 (10th Cir. 1989) ( per se rule condemns conduct without proof of power, effect or purpose and without hearing claims of legitimate objectives ). Catalano, Inc. v. Target Sales, Inc., 446 U.S. 643, 647-48 (1980) (per curiam); Citizen Publ'g Co. v. United States, 394 U.S. 131, 134-36 (1969); Socony-Vacuum Oil Co., 310 U.S. at 221, 223, 225 n.9; Vandervelde v. Put & Call Brokers & Dealers Ass'n, 344 F. Supp. 118 (S.D.N.Y 1972) (uniform discounts by brokers per se illegal). Gas transportation services also are regulated by the Federal Energy Regulatory Commission ( F E R C ) a n d s u b j e c t t o t h e a n t i t r u s t l a w s .
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK agreements with competitors to fix, raise, lower, or maintain quotas or prices for electricity and/or fuel to be purchased and/or sold in the market; agreements with competitors to fix, increase, decrease, or maintain any inside spread or the size of any quote increment for electricity and/or fuel to be purchased and/or sold in the market; agreements with competitors to adhere to any quoting convention concerning increments used to update quotes.
There is a critical distinction, however, between price fixing, which is strictly illegal, and an independent (and perfectly lawful) decision to match a competitor s price. Indeed, competition often requires a firm to match or better its competitors prices. Matching a competitor s business behavior is not illegal unless there is some agreement or understanding with a competitor to mirror a competitor s pricing or quoting practices. 24 Thus, it is perfectly acceptable from an antitrust standpoint for a firm to: unilaterally set its own bid and ask prices for electricity and/or fuel to be traded, the prices at which it is willing to buy and/or sell any volume of electricity and/or fuel, and the quantity (or volume) of electricity and/or fuel that it is willing to buy and/or sell; unilaterally set its own inside spread, quote increment, or quantity of electricity and/or fuel for its quotations; communicate its own bid and ask prices, or the price at which or the quantity of electricity and/or fuel that it is willing to buy or sell to any potential customer or supplier, for the purposes of exploring the possibility of a purchase or sale of electricity and/or fuel, and to negotiate for or agree to such purchase or sale; or take any unilateral action or make any unilateral decision regarding competitors with which it will trade and the terms on which it will trade.25 2. Price Fixing: Agreements that Indirectly Affect Price The prohibition against price fixing also bars agreements, understandings or arrangements or attempts to enter into such agreements, understandings or arrangements between or among competitors that indirectly affect prices or terms and conditions of sale, such as restrictions on output, participation in a market, or extensions of credit.26
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See Great Atl. & Pac. Tea Co., Inc., v. FTC, 440 U.S. 69, 83 n.16 (1979). United States v. Colgate & Co., 250 U.S. 300 (1919). Catalano, Inc., 446 U.S. at 645, 648.
ANTITRUST ENFORCEMENT 3. Agreements to Allocate Customers, Territories, Markets, or Products
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Competing firms should never agree with each other to divide or allocate customers or territories, or to refrain from selling a certain product generally or in any geographic area or to any category of customers. These agreements or arrangements between competitors, like price fixing, are always illegal.27 4. Agreements to Refuse to Buy from Particular Suppliers or Sell to Particular Customers Competing firms should not communicate with competitors concerning decisions whether or not to buy from or sell to any third party. Although a firm generally has the right to decide independently that it does not wish to buy from or sell to a particular person,28 such a decision becomes an illegal group boycott when reached jointly with a competitor, and may be illegal regardless of whether it may seem commercially reasonable or morally justifiable.29 Section 1 of the Sherman Act does not preclude sharing information through a trade association or otherwise regarding a particular customer s credit history, although the specific terms of credit and the decision to sell or not to sell to a particular customer should not be discussed. 5. Agreements to Control or Limit Production Competing firms should never agree to (1) limit the quantity or quality of production or the quantity of product that is to be sold to any customer or in any market; (2) refrain from introducing new products or services or from eliminating old ones; or (3) accelerate or postpone the introduction or withdrawal of a product or service.30 While in certain instances it is lawful for competitors to enter into an agreement to establish industry standards for
It is perfectly lawful, however, for states and/or their political subdivisions to award franchises to utilities to provide exclusive service in designated geographic territories. This is one instance in which FERC regulation is more restrictive than the antitrust laws, because Order No. 888 and FERC regulations require electric utilities to provide non-discriminatory open access to their transmission facilities. See Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Order No. 888, 61 Fed. Reg. 21,540 (May 10, 1996), FERC Stats. & Regs., Regs. Preambles Jan. 1991-J u n e1 9 9 63 1 , 0 3 6( 1 9 9 6 ) ( O r d e r N o . 8 8 8 ) , o r d e r o nr e h g , Order No. 888-A, 62 Fed. Reg. 12,274 (Mar. 14, 1997), FERC Stats. & Regs., Regs. Preambles July 1996-Dec. 2000 31,048 (1997), o r d e ro nr e h g , Order No. 888-B, 81 FERC 61,248 (1997), o r d e r o n r e h g , Order No. 888-C, 82 FERC 61,046 (1998), a f f d i n r e l e v a n t p a r t s u b nom. Transmission Access Policy Study Group v. FERC, 225 F.3d 667 (D.C. Cir. 2000), a f f ds u b nom. New York v. FERC, 535 U.S. 1 (2002); see generally Verizon Communications, Inc. v. Trinko, 540 U.S. 398, 412 (2004) (noting, in the context of Federal Communications Commission regulation, that the access provisions of the Telecommunications Act of 1996 significantly diminishes the likelihood of major antitrust harm). Northwest Wholesale Stationers, Inc. v. Pacific Stationery & Printing Co. , 472 U.S. 284, 293-95 (1985).
30 29 28 27
Hartford-Empire Co. v. United States, 323 U.S. 386, 406-07 (1945).
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products or service standards, such instances must be carefully monitored to ensure that the agreement will not have, intentionally or inadvertently, an anticompetitive effect. Accordingly, a firm should exercise caution when any of its employees enter into even preliminary discussions, either bilaterally or through a trade association, regarding the establishment of industry standards without first receiving guidance from legal counsel. 6. Agreements Regarding Bidding Practices A firm must take extreme care when preparing and submitting bids in response to requests for proposals. Direct or indirect agreements between or among competitors that affect bid prices is illegal. 31 The following types of agreements, understandings or arrangements between or among two or more competitors also are strictly prohibited: advance discussion or exchange of specific bid-related information (e.g., nonpublic cost information or outage information); submission of complementary, shadow,or protectivebids whereby competitors agree to submit token bids that are too high or contain special terms so as make them unacceptable while appearing genuine; bid rotation whereby competitors agree to take turns winning a recurring bid competition by being the low bidder; and bid suppression or retraction whereby competitors agree to refrain from bidding or withdraw their bids so that one competitor s bid will be accepted. 7. Communications with Competitors The unlawful agreements discussed above need not take the form of a written contract or contain express commitments or mutual assurances. Courts can and do infer agreements based on loose talk, informal discussions,or the mere exchange of pricing information between competitors if it is done outside of a legitimate purchase and sale context. Agreements can be inferred from parallel behavior coupled with an opportunity to discuss and/or agree upon prices. Any communication with a competitor s employee, representative or agent, no matter how innocuous it may seem at the time, may later be subject to antitrust scrutiny. The safest course is to avoid talking to competitors about competitively sensitive information unless it is necessary to do so, such as in connection with a specific purchase from or sale to that competitor in its capacity as a supplier or customer. All interactions oral as well as written with competitors, their employees, representatives or agents should be conducted as if they were completely in the public view and subject to probing examination and unfavorable interpretation by a government prosecutor or a treble-damages plaintiff.
31
Northwest Wholesale Stationers, Inc., 472 U.S. at 293-95.
ANTITRUST ENFORCEMENT a. Prohibited Topics of Conversation
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Other than in connection with a bona fide purchase and sale transaction, the following topics should be avoided in any communication between or among competitors, their employees, representatives or agents: prices and pricing policies, terms or conditions of sale (including discounts and allowances); credit terms and billing practices; suppliers terms and conditions; profits or profit margins; costs; marketing and/or distribution plans and practices; bids, including an intent to bid or not to bid for a particular contract or program; allocation of sales territories; selection, retention, or quality of customers and/or suppliers; refusals to deal with a supplier or customer; type or quality of production; new products, product innovations, or product eliminations; and new services, service innovations, or service eliminations. If a competitor initiates a conversation about any of these subjects, it is best to immediately and emphatically refuse to continue the discussion and to report the incident to legal counsel. b. Trade Associations and Other Industry Gatherings Trade associations meetings and other industry gatherings present a danger area under the antitrust laws because they bring together competitors people with common interests and problems who are prone to discuss matters of mutual concern. For that reason, membership in trade associations, while permissible, should be approved in advance by legal counsel and only after management has determined that the association serves an important and proper purpose and that all its activities are adequately supervised by counsel. Copies of all trade association minutes, agendas, or any other documents received from or provided to trade associations should be reviewed by legal counsel on a periodic basis.
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The most serious problems presented by trade association activities are apt to arise at informal social gatherings, particularly in a hotel room or hospitality suite after the official meeting has ended. A general gripe session at which one or more competitors expresses the view that prices are too low or that margins are being squeezed, followed shortly thereafter by price increases by some industry participants, could lead to an inference of an agreement to raise prices. It is best to avoid such situations, and to inform legal counsel of any troubling discussion or activity. c. Communications Through Brokers Brokers, acting as middlemen for purchases and/or sales of power and/or fuel, may be viewed by the antitrust enforcement authorities as facilitators of or conduitsfor pricefixing or bid-rigging schemes. It therefore is wise to be careful of loose talk when dealing with brokers who inadvertently may convey competitively sensitive information between or among competitors during purchase and sale negotiations. Information that provides insight into non-public costs or future bidding strategies (including decisions not to bid) may have an effect on future bid positions of others. Although unintentional, such information exchanges through brokers may trigger unwanted government scrutiny. Consequently, the operating assumption should be that brokers will pass on competitively sensitive information, so efforts should be made to ensure that such information is presented carefully and cannot be misconstrued to suggest unlawful coordination by market participants. 8. Competitors as Customers or Suppliers As mentioned above, it is not uncommon for competitors in one context to be customers or suppliers in a different context. It is entirely lawful to carry on bona fide customer and supplier relations with such companies, provided there is no improper discussion about situations in which the companies compete, or improper agreements relating to third-party customers or suppliers. It is important to train employees who are likely to interact with competitors, such as power traders, to recognize that a lawful conversation can become high-risk in a heartbeat, to internalize the parameters and limits of a proper conversation, and to react appropriately if the conversation turns toward a problematic subject. Such concepts should reinforce and dovetail with other training initiatives concerning a firm s corporate policies on business ethics and integrity, and handling of proprietary and other company confidential information. 9. Competitor Collaborations Competing firms sometimes collaborate to achieve legitimate business goals (e.g., research and development, product development, or construction of production capacity) that each competitor acting alone could not achieve as efficiently or at all. Such collaborations can take a variety of legal forms, but are typically referred to as joint ventures. Joint ownership of a generating unit by several competitors and the formation of regional transmission organizations are obvious examples of joint ventures in the electric power industry. Although a joint venture may be lawful, it also may raise difficult antitrust problems depending on (1) the nature of the venture s business activities, (2) whether the joint venture participants remain active in the same business or any closely related
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businesses, and (3) what steps are taken to control the flow of competitively sensitive information into and out of the joint venture. Competitively sensitive business information obviously includes pricing and cost information, and also includes any of the prohibited topics of discussion listed above. Discussions among joint venture partners should be limited to the subject of the joint venture. Because a joint venture often is an ongoing relationship that entails a close working relationship among the venture and its parents, potential antitrust problems or concerns may frequently arise. It is important for antitrust counsel to provide ongoing guidance concerning any joint venture among competitors. 10. Company Documents Regarding Competition It sometimes happens that interoffice documents or memoranda dealing with the subject of competition or competitors prices are written (perhaps to impress others in the organization with the writer s knowledge of the competitive situation) so as to suggest, contrary to fact, that there is some sort of understanding or sharing of information among competitors about pricing. Every memorandum or document on such subjects should merely state what the facts are and should contain no editorial comment other than, if appropriate, the writer s opinion as to the accuracy of what is being reported. If price information is given, the source of the information should be included in the memorandum to make it clear that it was obtained from a proper source, not from questionable exchange of competitively sensitive information. In effect, each memorandum or document should be written on the assumption that at some future date it will be produced for inspection by antitrust enforcement authorities or plaintiffs in a treble damages action who will tend to interpret any language in the worst light possible as evidence of anticompetitive intent. B. RELATIONS WITH CUSTOMERS AND SUPPLIERS
Certain arrangements between suppliers and their customers can restrict competition and therefore may be illegal under the Sherman Act. Such arrangements could arise in several electric power industry contexts, including in particular the marketing and sales of electric power. 1. Selection and Termination of Customers and Suppliers
In general, and absent a regulatory mandate to the contrary (e.g., FERC open access requirements), a firm has the right to choose the customers and suppliers with whom it will deal, provided that decisions not to deal with particular customers or suppliers are made independently and unilaterally.32 In the electric power industry, refusals to deal implicate a variety of statutory and regulatory requirements and should always be reviewed in advance with legal counsel. Similarly, a firm may unilaterally terminate a customer or supplier for legitimate business reasons, such as the customer s inability to pay or the supplier s failure to deliver
32
Verizon Communications, 540 U.S. at 408.
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products on time or within specification. The emphasis on unilateraltermination is important because any termination that is the result of an agreement with another party could be challenged as an illegal agreement under the antitrust laws. In making a unilateral decision to terminate a customer or supplier, a firm may use information about that customer or supplier received from competing customers or suppliers. However, the termination cannot be the result of collusion with those competing customers or suppliers. Decisions to terminate customers or suppliers also should be made fairly and with due regard for their legitimate interests. Due to the sensitivities and potential for litigation surrounding the termination of any commercial relationship, legal counsel should be involved in any termination decision and a contemporaneous written record should be created that clearly states the legitimate basis for the termination. 2. Exclusive Dealing
Exclusive dealingrefers to an exclusive sales arrangement by which a supplier agrees to sell to a customer only on the condition that the customer refrains from dealing with any of the supplier s competitors. Such agreements may be deemed illegal if they unreasonably restrain competition, based on the facts in each particular case.33 Nevertheless, a customer may choose to purchase all or substantially all of its requirements from a single supplier. However, a customer should not attempt to coerce a supplier into refusing to sell to the customer s competitors. In general, the safest course is not to interfere in any manner with a customer s or supplier s other commercial relationships. In any event, legal counsel should be involved whenever an exclusive dealing contract is contemplated. 3. Cooperative Purchasing
Cooperative purchasing agreements under some circumstances may constitute an unreasonable restraint of trade. While not all buying agencies or other cooperative buying arrangements are unlawful under the antitrust laws, there must be a justification for such activity, e.g., increased efficiencies or reduced costs, and there must be no adverse effect on competition. Accordingly, legal counsel should be involved in a decision to enter into any cooperative purchasing agreement. C. MONOPOLIZATION AND ATTEMPTS TO MONOPOLIZE
The law of monopolization and attempted monopolization is complicated, involving difficult questions about what constitutes monopoly power, intent to monopolize, the product and geographic markets in which the monopoly or attempt is measured, and what constitutes unlawful use of monopoly power. As a rule, when a product or service enjoys a strong market position (e.g., a significant market share of sales in a particular market), the seller of that product or service should be concerned with questions relating to monopolization, and legal counsel should be consulted with respect to the marketing and pricing of the product or service.
33
Tampa Elec. Co. v. Nashville Coal Co., 365 U.S. 320 (1961).
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In general, a firm with a strong market position must not take any actions that could be construed as evidence of an intent to acquire or maintain monopoly power, to drive a particular competitor out of business, or to prevent a person from entering the market.34 The following types of conduct have been held to be illegal as acts of monopolization or attempts to monopolize: localized price cutting in a competitor s primary market area with intent to drive that competitor out of business; sales below the average variable cost of producing and distributing additional product or providing additional service, or sales below the average total cost, in order to drive out competitors and then raise prices; and attempts to limit a competitor s access to a product to drive that competitor out of business. Nevertheless, the Supreme Court recently acknowledged that lawful conduct in pursuit of monopoly power is an important element of the free-market system. The opportunity to charge monopoly prices at least for a short time is what attracts business acumen in the first place; it induces risk taking that produces innovation and economic 35 growth. Moreover, the Court held that as a matter of law, where a federal or state statute or regulatory regime provides for access to so-called essential facilities (such as transmission facilities), a monopolization claim based on a refusal to deal theory cannot be maintained. The Court made clear that courts do not have the requisite expertise to adjudicate such claims, fashion effective remedies, and monitor compliance. Instead, such claims should be handled by the regulatory agencies with industry expertise. D. PUBLIC STATEMENTS, INTERNAL MEMORANDA AND CORRESPONDENCE
Enforcement authorities, competitors and customers frequently monitor a company s statements for any suggestion of conduct that may have anticompetitive consequences. Statements to the effect that a firm dominates or controls a market will raise the concerns and suspicions of these observers. Consequently, care should be taken to avoid any inference that a firm has engaged in conduct that might restrict or eliminate competition. If there is any doubt concerning whether a particular statement is appropriate, legal counsel should be consulted. Careful language will not avoid antitrust liability when the conduct involved is illegal. Conduct that is perfectly legal, however, may become suspect because of poor word selection or a misleading manner of expression. Avoid unnecessary and perhaps inaccurate characterizations regarding intangibles such as purpose, intent, and state of mind. Careless and inappropriate language can have an extremely adverse effect on a firm s or an individual s position in an antitrust investigation or lawsuit.
34 35
See Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585, 602 (1985). Verizon Communications, 540 U.S. at 408.
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Under discovery procedures, the Justice Department, the FTC, a state attorney general, and private litigants may have broad access to a defendant s documents and data. Materials that may have to be disclosed are not limited to final versions of memoranda or letters, but also include drafts, handwritten notes, individual calendars and diaries, expense records, telephone records, trader tapes, voicemail messages, email, instant messaging, and all other material that can be retrieved from a computer or computer network. Bear in mind that with increased use of computers and electronic messaging, documents are often widely distributed and saved indefinitely. Copies are often kept on back-up systems, unbeknownst to the author. Similarly, documents maintained in personalfiles or on laptops or kept at home typically must be produced. All documents and electronic communications should be carefully written so as to avoid misstatements of fact and inferences or conclusions that might be misinterpreted or taken out of context by a suspicious person. III. SIGNIFICANT UNCERTAINTIES
The main source of antitrust uncertainty (i.e., risk) for participants in the electric power industry is the absence of routine regulatory activity by the antitrust enforcement agencies. Unlike expert state and federal regulatory agencies, the antitrust agencies do not publish rules or regulations that prescribe specific business conduct that, if followed, will be deemed compliant with the antitrust laws. In addition, they do not mandate the creation and retention of particular business records, periodic filings, occasional compliance audits or other processes that ordinarily provide calibration and feedback concerning antitrust compliance. Moreover, although the antitrust agencies monitor developments in the industry, they become familiar with individual companies or the workings of particular markets only in the course of investigating conduct or mergers that may violate the antitrust laws. Conduct investigations may be triggered by complaints from customers, suppliers or competitors anyone who would benefit in a private treble damages action if an antitrust agency were to establish that an antitrust violation occurred. In particular, it is not uncommon for companies that find themselves in financial difficulty to allege anticompetitive conduct by others in the marketplace as the source of their troubles. Similarly, because merger investigations may result in mandatory dispositions of assets, other market participants may have an extra incentive to cooperate with antitrust investigators. Antitrust agencies are acutely aware that the complaints of private parties may be driven by ulterior motives, but they will pursue allegations that appear to be based on plausible theories of harm to competitive markets, not just individual companies. IV. COMPLIANCE RECOMMENDATIONS
In view of the potential penalties for both companies and individuals, there is an obvious need for all directors, officers and employees of a firm to be familiar with the antitrust laws. Following ethical business practices is not sufficient, for inadvertent violations can occur and have occurred in good companies, and good intentions are often held to be irrelevant. Pursuing an anticompetitive course of conduct for the good of the industry, for the benefit of a customer, or even because it seems to be the right thing to do will not excuse the resulting violation of the antitrust laws.
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Appearances as well as actual facts are important. A violation of the antitrust laws can be established by circumstantial evidence alone, even though there is direct evidence contradicting the existence of such a violation. It is far better and easier to avoid situations and actions that might convey an erroneous impression than to have to explain them in the future when an antitrust investigation or action is in progress. Consequently, to ensure compliance with the antitrust laws, a company should: E s t a b l i s ha n dp u b l i s hac l e a rs t a t e m e n t t h a t i t i st h ec o m p a n y sp o l i c yt o comply with the antitrust laws. Publish a compliance guide containing the policy statement and instructions on how to comply with the antitrust laws, and require employees to sign a form acknowledging that they have read and agree to comply with the policy. Conduct mandatory annual training sessions for employees on how to comply with the antitrust laws. Designate at least one in-house attorney to be a resource for business people to contact with antitrust questions or issues, and arrange for additional antitrust training for that attorney. E s t a b l i s ha t i p l i n e t h a t a l l o w s e m p l o y e e s t oa n o n y m o u sly report potential v i o l a t i o n s o f t h e c o m p a n y s p o l i c y . Consult with outside legal counsel when in doubt about any decision or course of conduct.
Chapter 20 Records Retention

CHERYL FOLEY I. NATURE AND PURPOSE OF THE REQUIREMENT
Records retention requirements have three basic purposes. The first is to ensure regulators that authentic utility records and documentation exist to permit them to carry out their statutory functions. The second is for the protection of the utility itself: its corporate, accounting and commercial records allow it to prove, among other things, ownership of property, rights to perform activities, compliance with legal and regulatory requirements, rights to collect monies, and rights and responsibilities of commercial contracts and dealings with third parties. The third purpose is to provide a consistent and orderly framework for the destruction of certain documents to reduce the burden and risks associated with perpetual retention of every paper, draft, study, data, email, voicemail, and other corporate documentation. II. A. SUMMARY POTENTIAL COMPLIANCE ISSUES
Most governmental agencies have adopted policies governing the retention of records that are relevant to the matters within their jurisdiction.1 The general rules of the Federal E n e r g yR e g u l a t o r yC o m m i s s i o n( FERCo r C o m m i s s i o n ) , the Securities and Exchange C o m m i s s i o n ( SEC ) and the C o m m o d i t i e s F u t u r e T r a d i n g C o m m i s s i o n ( CFTC ) regarding records retention include the following:2
Counsel, Skadden, Arps, Slate, Meagher & Flom LLP. Prior to joining Skadden in 2001, Ms. Foley served as vice president, general counsel and corporate secretary of Cinergy Corp., and its predecessor, PSI Resources, Inc. It should be noted that except as specifically required by any federal, state, local or regulatory body or law, a utility is not required to retain corporate records and other corporategenerated documentation, but may choose to do so to accommodate business purposes. This is not intended to be an exhaustive list of all regulations pertaining to records retention for each of these agencies. Rather, it is an illustrative collection of certain records retention regulations for these agencies. Of course, a company may be subject to records retention regulations promulgated by various other federal or state agencies, such as the Internal Revenue Service, the Environmental Protection Agency, or the Occupational Safety and Health Administration, among others. An in-depth treatment of the scope of any specific requirements is beyond the scope of this chapter.
2 1
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Except as otherwise required by specific FERC rules, 3 Part 125 of FERC s Rules and Regulations sets forth the records retention schedules for public utilities and FERC licensees.4 Part 210 of the S E C s Rules and Regulations includes the records retention schedules for audits and reviews of the financial statements of issuers of securities.5 Part 1 of the CFTC Rules and Regulations includes the records retention schedules for activities subject to CFTC jurisdiction.6
Although these rules differ in many respects, it is fair to state that certain general principles apply to records retention, such as: Records that are required to be retained must be indexed, must be protected from damage, and must be accessible and easily retrieved. Records may be retained for a period longer than specified by the applicable law, at the option of the utility. Records may be destroyed at the end of the legally required retention period, at the option of the utility, if no investigations or litigation are pending. If a utility is involved in pending litigation, complaint procedures, investigations or other governmental proceedings, it must retain all relevant records during the pendancy of those proceedings. B. COMPLIANCE ISSUES 1. What i s a r e c o r d ? Historically, the term r e c o r d s referred to actual hard copydocuments and other recorded material. This included not only official corporate documents, but also other types of records, such as letters, memos, drafts, notes of meetings and phone calls, appointment logs, calendars, studies, tapes, pictures or videos, and all copies of such material. Today, the concept o f a r e c o r d is generally much broader, and includes any type of electronic record that may be created, such as emails, electronic logs of incoming and outgoing communications, any data created or stored in electronic format, daily system backup files, and virtually any other recordation, like voice messages, that has been reduced to a
See, e.g., 18 C.F.R. 37.7 (2005) (setting forth certain retention requirements for Open Access Same-t i m e I n f o r m a t i o n S y s t e m( O A S I S ) d a t a ) .
4 5 6
Id. 125.1-125.3. 17 C.F.R. 210.2-06 (2005). Id. 1.31-1.39.
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retrievable format. Records can even include previously deleted files and data, if they are retrievable through available technology. The types of items t h a tc o n s t i t u t ea r e c o r d f o rp u r p o s e so fs p e c i f i cl e g a lo r r e g u l a t o r yr e q u i r e m e n t s ( s u c ha s P a r t 1 2 5o f F E R C s Rules and Regulations) are typically defined by and within the applicable laws or regulations themselves. For example, a rule or regulation may require retention of an official copy of the corporate bylaws or an original copy of a commercial contract. In those instances, only the document specified by the regulation is required to be maintained. Copies, drafts, electronic versions, notes and other documentation related to the document are not subject to retention, unless specifically required by the rule or regulation. Normally, a company is bound only by the applicable rules and regulations. A records retention program, therefore, should be structured at a minimum to achieve compliance with those specific rules and regulations. Generally, a c o m p a n y s r e c o r d s r e t e n t i o n p r o g r a me xtends beyond statutory and regulatory requirements to include business considerations as well. Some of these considerations are discussed below. In addition to the regulatory requirements governing normal business operations, the onset of litigation, investigations or other legal or governmental proceedings can trigger significant additional record retention requirements. For instance, a company may be required to retain a wide range of retrievable information t h a t m a yb e r e l e v a n t t ot h e c a s e or investigation at hand. Determining what is relevantis almost always a highly factspecific endeavor. T h e c o m p a n y s normal records retention compliance program most likely will not be sufficient to address all of the circumstances or subtleties associated with a particular legal case or investigation, and specific ad hoc programs will need to be developed quickly to protect the company from civil and possibly criminal liability. 2. What are the risks of a poorly constructed or inconsistently implemented records retention program? The risks of not having a formal records retention program, or having one that is poorly designed or inconsistently implemented, can be significant. In extreme circumstances, civil and criminal penalties can be imposed against companies as well as individuals, as discussed in more detail below. For example, under its new statutory authority, FERC may now levy civil penalties up to one million dollars per day per violation of its rules and regulations, including its records retention requirements, such as set forth under Rule 5 of its Market Behavior Rules.7 Poor records retention policies also threaten a company s credibility. Without adequate documentation, a company may be unable to establish the scope of its rights and obligations or its compliance with applicable laws. On the other hand, excessive retention of documents may produce harmful complications in an adversarial situation. Consequently, a sound balance must be struck in developing a records
Investigation of Terms and Conditions of Public Utility Market-Based Rate Tariffs and Authorizations, Order Amending Market-Based Rate Tariffs and Authorizations, 105 FERC 61,218 (2003), reh'g denied, 107 FERC 61,175 (2004).
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retention policy. That balance will necessarily differ from company to company, and with respect to the type of record at issue. C. POTENTIAL COMPLIANCE ISSUES 1. Designing a comprehensive records retention program Most elements of a basic records retention program can be constructed by simply building systems and processes that reflect the specific requirements of the applicable rules a n dr e g u l a t i o n s .F o r e x a m p l e , o n e o f t h e r e q u i r e m e n t s o f F E R C s r e c o r d s r e t e n t i o nr u l e s i n Part 125 is that general accounting ledgers be kept for ten years. Such a requirement is straightforward and should be easy to comply with through a thoughtfully designed and consistently implemented program. However, one of the challenges of designing a records retention program is deciding what types of records should be kept in addition to those clearly required by law or regulation or for a period longer than that legally required. For example, some companies may decide that transmission postings (required under 18 C.F.R. 37.6) should be retained for periods longer than those specified in 37.7, or that all drafts of contracts or notes on negotiations and meetings (not generally required by law to be retained) are to be maintained. Other companies may determine that the time periods specified in the regulations are to be strictly complied with or that only the final version of a contract or study should be maintained, and that personal notes of meetings or negotiations are not to be retained. Still others may not have a corporate policy with regard to these types of issues, leaving them to the discretion and preferences of individual employees. Generally, the benefit of retaining documents not required by law, or in excess of the time periods required by law, is that of having the detailed history of a corporation, its accounts, transactions and past negotiations readily available to business decision makers. From a regulatory or litigation standpoint, retention of drafts, preliminary studies and other similar types of documents can be either positive or negative, depending entirely on their content and the issue at hand, which can never be known ahead of time. If a company retains only final versions of contracts, studies, and other documentation, regulators and/or adverse parties in litigation may be forced to focus on the final productas opposed to any intermediary stages of its production. In regulatory proceedings or litigation, this approach may help to limit exposure of and inquiries into sensitive issues, potential liabilities and risks often faced by management in its decisionmaking process.8 It also removes much of the subjectivity from the document retention process and is likely to be less costly and administratively burdensome, in that fewer documents will need to be retained.
It bears noting, however, that a counterparty may keep drafts of contracts (for instance) that may resurface in litigation, causing surprise if a company has not maintained its own documentation.
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As discussed above, there are pros and cons to each approach, but, from a compliance standpoint, consistency and adherence to the corporate process is perhaps the most important consideration. If, as an example, a company determines that postings are to be retained for a period longer than required by the regulations or that preliminary drafts are to be preserved, t h e n f a i l u r e t o d o s o c o u l d b e u s e d t o d i s c r e d i t o r u n d e r m i n e t h e c o m p a n y s p o s i t i o n i n a l a t e r dispute or could even imply a cover-up. Conversely, if a company decides that retentions standards should be rigidly adhered to or that no preliminary material should be kept after a study is finalized, later discovery of material kept in contravention to these policies can call into question when and how other preliminary documents may have been preserved or destroyed, again, potentially threatening t h ec o m p a n y s c r e d i b i l i t y .Thus, maintaining and uniformly enforcing the corporate policy on such matters is key to the proper functioning of t h ec o m p a n y sr e c o r d sr e tention program and to positions the company may take in adversarial situations. 2. Consistent follow-up and implementation of a records retention program In addition to a well-designed program, consistent, timely and comprehensive implementation is critical. I n m o s t c o m p a n i e s , r e c o r d s r e t e n t i o n i s a s i d e t o t h e c o m p a n y s main business activities, and can be delegated down within the organization to administrative personnel that are not actively engaged in the business itself. These people may be welltrained in records retention requirements, but often are not aware when a contract is signed, a bylaw is changed, a regulatory filing is made, or other documentation is created that needs to be retained in the corporate files. The records retention program, therefore, must take care to e d u c a t e a l l p e r s o n n e l w h om a y c r e a t e r e c o r d s i nt h e n o r m a l c o u r s e o f b u s i n e s s t op r o v i d e the requisite documents to the corporate records center in a timely manner. In the absence of a well-organized and well-communicated corporate-wide records retention program, each individual employee may devise his or her own system of records retention, ranging in extremes from the pack rat approach to the toss everything mentality. Although it may not be possible to achieve perfection, a well-designed records retention program should assure that personnel within the different operating areas of the company know and understand their responsibilities to retain records they generate, including whether they are to be sent to corporate files or whether they are to be maintained within the department, and if so, how they are to be organized and stored, and when and under what circumstances files can be culled. Periodic internal audits of operating departments to identify potential gaps in records retention compliance may be a specific design element of the records retention program or may simply be done periodically as part of a general internal audit program. Technology also may help to identify and retain certain types of records. Systems can be developed that have retention programs built into them or that automatically load specified data or records into a corporate records file. To the extent that retention of required records can be automated, the potential for human error can be minimized and the retention program can be strengthened. The other side of incomplete and inadequate retention of documents is failure to abide by corporate guidelines when it is time to eliminate a retained record. Problems in this area
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are compounded by technological advances that increasingly permit retrieval of records previously considered deleted or destroyed.9 3. Physical retention issues a. Storing Hard Copies Storage and retrieval of hard copy records is a difficult, labor intensive and expensive endeavor. It requires (1) large amounts of physical space, either onsite or offsite from a c o m p a n y sprimary place or places of business; (2) that such space be environmentally secure, with access that is limited and controlled; and (3) that records be subject to quick and easy physical retrieval. It can also require a tremendous amount of physical labor to catalogue, store, retrieve, and destroy hard copy records according to the retention program. Further, storage of files within a department, rather than in a centralized corporate location, can raise security concerns and information can be difficult to access if not kept in a uniform and organized manner. Haphazard corporate storage practices such as utilizing attics, basements, or office closets to store documents may have been employed by a company in the past and may still be in use today, particularly for old records. In one recent instance of which we are aware, records up to one hundred years old were kept in the attic of an office building where humidity and insects had taken their toll. Some of the records should have been discarded many years ago, and others should have been kept in pristine condition. It took many months to sort through and apply a modern records retention program to the documents that could be restored. b. Electronic Storage Electronic storage is much less expensive than storing hard copies, and can be much easier to handle physically, but is not without its problems. An electronic storage program can facilitate corporate records retention, allowing massive storage capability within a small physical space, simplifying back-up protection, and providing relatively quick, easy, inexpensive, and comprehensive access to information (assuming accurate filing and adequate indexing, search and retrieval systems). On the other hand, digital records can be doctored, destroyed or widely distributed to unauthorized individuals, even more easily than can a hard copy document. Access to this information therefore must be strictly limited and its security must be well protected. Firewalls must be built and maintained and security systems implemented that prevent unauthorized access to or distribution of confidential corporate information. This process can become expensive, and is constantly open to the potential of invasion from hackers. To the extent that the retention system is entirely internal and offline, a company can be fairly confident in its security, but it is ordinarily not practical for all corporate documentation to be protected in this manner. One problem in today s increasingly electronic business environment is the informal retention of data that occurs within a company on an everyday, routine basis. This often
9
See infra section II.B.5 (regarding destruction of records).
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unintentional retention i n c l u d e sa l l k i n d so f r e c o r d s , i n c luding voicemail, email, drafts, studies, communications and other informal documentation that may not be intended to be p a r t o f a n y r e c o r d s r e t e n t i o n p r o g r a m , b u t i s n e v e r t h e l e s s r e t a i n e d i n e l e c t r o n i c f o r m a t f o r some period. In some cases, a rational retention program can be designed. For example, email or voicemail can be automatically deleted by the system after a specified number of days. However, these protections can be bypassed if an employee stores the email in a different file or downloads it to hard copy and saves it. Further, an employee can delete an electronic file, but that file may have been recorded in a backup file that may or may not be overwritten at some point in the future. In other words, electronic records retention and the capability to access electronically recorded data create many challenges that make uniform corporate control an elusive goal. 4. Access to retained materials Once corporate material has been preserved under a records retention program, subsequent access to that material must be managed. Protocols need to be adopted as to who may have access to what materials and when, why and how that access is to be granted. For example, when dealing with entities and/or individual employees subject to the informationsharing restrictions of FERC s Standards of Conduct and Codes of Conduct10 regulating intra-company and affiliate relationships, a company must ensure that access to restricted material continues to be properly limited. The security and authenticity of original records must be protected.11 Accurate and comprehensive indices must be prepared that allow quick retrieval of specific information. Finally, systems must be put in place to assure that any materials retrieved are timely returned to the proper place of storage. 5. How to ensure consistent and timely destruction of records and corporate documentation that the law does not required to be retained One of the major challenges in crafting an effective document retention program is ensuring that a corporation develops and implements a systematic method to eliminate corporate documentation that should no longer be retained. The first step in this process is to create a list of retention schedules for all records formally retained under the program, 12 and to identify in that list the physical or electronic location of each record. The second step is to actively monitor this list, to periodically prepare a destruction schedule that is to be circulated to responsible individuals, and to require those individuals to certify that the designated record should be destroyed, there being no outstanding investigation, litigation or other reason why the record should continue to be preserved. Since certifying that a p e r m a n e n t c o r p o r a t e r e c o r dnow can be forever destroyed is something that many people find an uncomfortable task, there needs to be monitoring and follow-up. Without such vigilance, it is likely that many destruction schedules will never be fully implemented.
10 11 12
See Chapters 10 and 11. See infra section II.C.6 (discussing authentication of records).
As noted previously, for example, FERC rules at 18 C.F.R. Part 125 specify minimum retention periods for certain types of documents.
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Another issue arising out of a records destruction program involves identifying those individuals who should have the authority to make the final decision, the standards they are to use to make that decision, and the flexibility they have to deviate from the formal rules and standards. Developing objective standards in this area promotes consistency and protects the credibility of the records retention program. 6. Authentication of records In certain instances, corporate records will need to be authenticated. This process typically requires an affidavit confirming that a corporate record is the original or an accurate copy that has not been tampered with or altered from its original form. To authenticate certain types of documents, a corporation may need to establish a chain of custody to verify that the record has not been accessible to or accessed by any individual other than the p e r s o n ( s ) r e s p o n s i b l e f o r i t s s a f e k e e p i n g .F o r e x a m p l e , o r i g i n a l r e c o r d i n g s o f p o w e r t r a d e r s taped transactions could be subject to tampering and should therefore be stored in a secure location, accessible only by a designated individual(s), with copies only available for later use. The person designated as the responsible record keeper should be able to verify the authenticity and accuracy of the record or document at all times. Similar issues can arise with regard to all corporate documentation, but are especially critical in the case of electronic data that may be accessible by numerous individuals from time-to-time, thus becoming susceptible to manipulation. 7. Compliance in the face of litigation or an investigation or other legal or governmental proceeding When an investigation is commenced or litigation is threatened or filed, the obligation to retain relevant documentation expands dramatically. As soon as a company becomes aware that an investigation has commenced or that litigation is threatened, it must take care not to destroy any relevant material that has been generated in the past, and it must retain any relevant material that is created during the pendancy of the proceeding. Serious charges, including obstruction of justice, can be levied if proper retention procedures are not strictly followed. These charges can implicate individuals, as well as the corporation. Lawyers are not immune from investigation and prosecution for such offenses, particularly if they are in charge of the investigation or litigation and if they have the responsibility to direct and oversee the required records retention. The size and complexity of modern corporations makes retention of documents in the context of an investigation or litigation a difficult task. Some of the key considerations in such a situation include the following: First, one or more individuals immediately must be assigned the responsibility of ensuring that appropriate records retention occurs. This includes (among other things) identifying what might be a relevant document, which may be difficult, particularly during the preliminary stages of an investigation or litigation. Second, all employees (including clerical, field personnel, and others) who might have access to relevant documents must be identified and alerted to the fact that such documents must be preserved until further notice. Third, employees must be instructed on how to handle currently generated information. Fourth, automated destruction programs such as those that
RECORDS RETENTION
325
may be tied to email or voicemail systems need to be evaluated in light of the requirements of the investigation. III. COMPLIANCE RECOMMENDATIONS
Although records retention programs can vary substantially from company to company, and industry to industry, the following are suggestions for some basic elements of a successful program: Generate a centralized list of all legal and regulatory records retention requirements. Review or audit the current records retention program to assure that it conforms to these requirements. Establish a process for periodic review. Survey records retention sites to assess safety, security and access to required information and records. Periodically review the compan y s e l e c t r o n i c s y s t e m s a n dp r o t o c o l s t oa s s e s s security and accessibility, retention practices and capabilities, and deletion and destruction capabilities. Periodically review new technologies and developments for changes in these capabilities. Educate appropriate operating employees, not just administrative records retention personnel, as to corporate records retention requirements. Link the training requirement to human resources programs for new hires and transfers and conduct periodic refresher training. Include records retention compliance issues within periodic internal audit reviews. Circulate to appropriate operating, legal and regulatory personnel on a periodic, but at least annual, basis a list of files scheduled to be destroyed. Obtain signoff for and ensure destruction consistent with the corporate program. Conduct an annual file review and clean-out day, where employees review their files (including their electronic files) to identify any documents or other materials that need to be sent to corporate records, any that need to be refiled or indexed differently, and any that need to be discarded or deleted. Devise early alert systems to identify litigation or investigations that may require expansion of the normal records retention program.
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ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK Periodically review your overall program and make adjustments where you identify problems. IV. PENALTIES
Penalties for failure to retain documents and records as required by law depend on factual circumstances, such as the nature of the document and whether the failure to retain was inadvertent, negligent, or intentional. At the very least, and regardless of whether it was caused by inadvertence, negligence or was an intentional act, a failure to produce critical documents in an adversarial proceeding can result in a presumption against the offending party or in the denial of the requested relief. For example, a utility may not be able to include and recover costs in the rates it charges customers without adequate documentation that those costs were actually incurred for the purpose asserted. Similarly, failure to retain for the required period and provide documentation that a required posting or notice was made will likely result in a presumption that it was not made. If this occurs, a presumption against the utility could precipitate allegations of violations of tariff provisions or Codes and Standards of Conduct, with concomitant penalties levied against the utility. In addition to negative presumptions and rate and tariff-related penalties under the Federal Power Act, failure to retain required documents in violation of a statute, rule, regulation or order also can result in the imposition of civil or criminal penalties under governing statutes.13 If a company exercises diligence in retaining records for the required period and in preventing unauthorized destruction during litigation, it is unlikely that it will be held either civilly or criminally liable if documents are inadvertently destroyed. Negligence in document retention practices, however, could give rise to civil penalties. Intentional destruction of documents in violation of a legal requirement could result in both personal and corporate criminal liability, including obstruction of justice charges.
See, e.g., Energy Policy Act of 2005, Pub. L. No. 109-58, 1284(e), 109 Stat. 954, 980 (2005) (amending 16 U.S.C. 825o-1), which expands the authority of FERC to levy both civil and criminal penalties. FERC now has the authority to levy civil penalties of up to $1 million per day for violation of the FPA, or any rule, regulation, or order issued thereunder. Criminal penalties of up to $1 million and/or imprisonment of not more than five years may be imposed for statutory violations, a n d c r i m i n a l p e n a l t i e s f o r v i o l a t i o n s o f F E R C s r u l e s a n d r e g u l a t ions have been increased to not more than $25,000 per each day of violation.
13
March 20, 2006
SKADDEN COMPLIANCE HANDBOOK UPDATE:

FERC Audits and Penalties, the New Anti-Manipulation Rules, Interlocking Directorates, Q F s , and Electric Power Grid Reliability
If you have any questions, please contact any of the following Compliance Team Members: Mike Naeve 202/371-7070
mnaeve@skadden.com
Bill Scherman 202/371-7060

wscherma@skadden.com
John Estes 202/371-7950

jestes@skadden.com
This is the first in what we expect will be a series of occasional updates to our December 2005 publication Energy Regulatory Compliance: The Skadden Handbook. This update covers developments involving Federal Energy Regulatory Commission ( F E R C o r C o m m i s s i o n )audits and investigations (Ch. 2), penalties for noncompliance (Ch. 3), the new Market Manipulation Rules (Ch. 9), interlocking directorates (Ch. 12), qualifying facilities under PURPA (Ch. 14), and reliability (Ch. 16). The recent developments discussed here reinforce our belief that the Energy Policy Act of 2005 ( E P A c t 2 0 0 5 ) and FERC s initiatives create what is rapidly becoming a new regulatory paradigm one that places enormous importance on forward-thinking company compliance policies and training and then on full corporate cooperation in the event of self-reported violations or FERC-initiated investigations. We are sending this update to you in both hard copy and electronic format. Please feel free to use the pocket in the back of the Handbook for storage of these mailings. We expect to be sending another update soon when FERC acts on rehearing of its Section 203 and PUHCA 2005 rulemakings. For more information concerning these or other issues, please contact one of Skadden s compliance attorneys.
Dana Freyer 212/735-2506 dfreyer@skadden.com Noel Symons 202/371-7166

nsymons@skadden.com
Jerry Richman 202/371-7232

grichman@skadden.com
David Hill 202/371-7259

djhill@skadden.com
* * * This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum may be considered advertising under applicable state laws.
WWW.SKADDEN.COM
CHAPTER 2 (FERC AUDITS AND INVESTIGATIONS) GERALD RICHMAN FERC Issues Final Rules Expanding Procedural Rights of Targets of Operational Audits And Clarifying Audit Practices On February 17, 2006, FERC issued Order No. 675, promulgating final regulations for the disposition of Commission audits. 1 Order No. 675 establishes procedural rights of audited companies that disagree with Staff audit findings particularly companies that are the target of so-called operational auditsand provides additional, overall guidance with respect to the audit process. In Handbook Chapter 2, we noted a distinction between FERC s procedures for financialaudits audits that focus on accounting treatments under the Uniform System of Accounts and operationalaudits audits that focus on compliance with other substantive statutory and regulatory requirements (e.g., Standards of Conduct, Code of Conduct, and market rules). FERC s regulations provided that when a company that was the subject of a financial audit disagreed with audit findings, it had the opportunity, prior to issuance of a Commission order on the merits, to formally challenge Staff s findings either through a so-called shortened procedurebasically, a paper hearing in which the company and interested parties submit written memoranda or a trial-type proceeding before an administrative law judge. There were no similar regulations for operational audits, however. With operational audits, the practice had been that FERC Audit Staff communicated proposed audit findings and remedies to the company in draft form, and the company was given a certain number of days to submit written comments (or challenges to findings or proposed remedies). Following receipt of the comments and subsequent discussions with the company, the Office of Market Oversight and Investigations ( OMOI ) typically issued a public report, often containing recommendations to which the company had committed. On October 20, 2005, the Commission issued a notice of proposed rulemaking to formalize procedures for operational audits.2 The Commission proposed to amend its regulations for financial audits to cover all operational audits under the Federal Power Act ( FPA )3 (as well as audits under FERC s jurisdictional authorities over natural gas companies and oil pipelines). The Commission had not acted on this proposal by the time the Skadden Compliance Handbook
Procedures for Disposition of Contested Audit Matters, Order No. 675, 114 FERC 61,178 (2006) ( O r d e r N o . 6 7 5 ) . Procedures for Disposition of Contested Audit Matters, Notice of Proposed Rulemaking, 113 FERC 61,069 (2005).
3 2
16 U.S.C. 791a to 825r (2005).
went to press, but on February 17, 2006, the Commission adopted the proposed rules with certain clarifications.4 Under the new rules, which become effective on March 29, 2006,5 following completion of the audit process the Commission will issue an order on the merits with respect to nondisputed audit matters contained in a notice of deficiency, audit report, or similar document, and will notice, without making any findings on the merits, any disputed audit matters. The audited company may then elect to challenge the disputed audit matter through shortened procedures or a trial-type proceeding. The Commission states that it will honor this election unless FERC itself determines that there are no material facts in dispute which require a trial-type proceeding. In addition, Order No. 675 addresses the following points: In allowing participation by interested entities, the Commission will use the same standards governing interventions in other proceedings (e.g., the intervenor is a state public service commission, is a person with an interest that may be directly affected by the outcome, etc.). An interested entity that participates in shortened procedures will have access only to publicly available filings, and not nonpublic communications between FERC Staff and the audited company. Discovery in trial-type proceedings will be governed by the Commission s Rules of Practice and Procedure, with the presiding administrative law judge ruling on discovery motions. The initial election between shortened procedures and trial procedures belongs to the audited company, and the Commission declines to permit interested entities to participate in that election. Order No. 675 emphasizes the continued usefulness of informal discussions between an audited company and FERC Audit Staff, noting that the Final Rule is not intended to discourage such informal contacts. While the Commission declined to establish a specific informal procedure,Order No. 675 notes that an audited company can request to speak with management of the Audit Staff at any time during an audit up to the time that the company indicates in writing that it contests specified findings or proposed remedies. Moreover, Order No. 675 emphasizes that the current practices regarding wrap-up conferences and draft audit reports will continue. In other words, at the end of the audit process, Audit Staff will provide the company with a draft audit report for review and comment. The audited company then will be provided a wrap-up conference with Audit Staff and management to try and resolve disputed issues, clarify points, and discuss proposed findings and remedies.
4
At least until further notice, the new rules will not apply to audits conducted by the new Electric R e l i a b i l i t yO r g a n i z a t i o n( E R O ) a u t h o r i z e du n d e rE P A c t 2 0 0 5 , P u bL . N o . 1 0 9 -58, 119 Stat. 594 (2005), or reliability audits conducted by the Commission or its Staff. See discussion infra regarding Chapter 16.
5
See 71 Fed. Reg. at 9698 (2006).
3 MSW - Draft March 7, 2006 - 8:30 PM
A company can choose not to challenge one or more audit findings but still challenge one or more proposed remedies. At the same time, the Commission reserves the right to revise an audit report even where no party challenges the contents. In such circumstance, the audited company may seek rehearing of the Commission order. Unless the Commission expressly states that it is making findings that apply to other parties, an audit report and a Commission order approving an uncontested audit report like an order approving an uncontested settlement will not have precedential value. However, if an audited company contests audit findings through either shortened or trial-type procedures, the matter becomes an on-the-record proceeding and the legal reasoning and conclusions of the resulting order will apply to non-parties. Noting the expectation of cooperation that the Commission spelled out in its October 20, 2005 Enforcement Policy Statement6 Order No. 675 clarifies that efforts by an audited company taken in good faith to resolve issues that arise in the course of an audit will not be construed as evidence of non-cooperation. For example, where the company believes that data requests create a substantial burden that could be relieved by limiting the scope of the request, by providing other information that would achieve the same purpose, or by some other resolution that would satisfy Audit Staff, the company is not failing to cooperate if it suggests changes to, or narrowing of, the data requests. In addition, Order No. 675 expressly states that a company may have counsel present at any time during an employee interview. Similarly, a company that appropriatelyinterposes the attorney-client privilege will not be considered noncooperative. In this last regard, however, the Commission expressly warns that the interposition of the privilege where it does not apply and that is designed to frustrate 7 Audit Staff s efforts to obtain information could be evidence of non-cooperation. In response to comments, the Commission expressly states that its regulations governing non-public investigations8 do not apply to audits. However, Order No. 675 emphasizes that audited companies provide information to FERC Audit Staff on an non-public basis, and that section 301(b) of the FPA9 and section 8(b) of the Natural Gas Act ( NGA )10 provide that no Commission employee may divulge any fact or information derived during the course of an audit without express Commission (or court) directive. Order No. 675 also notes the Commission s regulation on confidential submissions.11
Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement on Enforcement, 113 FERC 61,068 (2005) ( Enforcement P o l i c yS t a t e m e n t ) .See Chapters 1, 2, and 3 of the Skadden Compliance Handbook.
7 8 9 10 11 6
Order No. 675, 114 FERC 61,178 at P 35. 18 C.F.R. Part 1b (2005). 16 U.S.C. 825(b) (2000). 15 U.S.C. 717g(b) (2000). 18 C.F.R. 388.112.
At the same time, the Commission states that information obtained in an audit may be shared by Audit Staff with Commission Staff conducting a related investigation. Indeed, prior to a matter becoming a proceeding (i.e., while it is still an audit or investigation), Order No. 675 states that FERC s separation of functions requirement does not apply. On the question of so-called best practices,Order No. 675 acknowledges that because a practice was successfully implemented by one audited company does not necessarily mean that practice will be a good fit elsewhere. The Commission adds that practices that companies implement to improve compliance may serve as useful references, but they are not binding on others. FERC Launches Operational Audits to Cover Compliance With Rules on Interlocking Directorates Operational audits over the past several years have focused on the FERC Standards of Conduct and Codes of Conduct, but recent action by FERC s OMOI indicates a heightened interest regarding compliance with the Commission s rules requiring prior authorization for individuals to hold interlocking positions that otherwise would be proscribed by Section 305(b) of the FPA.12 See Handbook Chapter 12. Letters issued February 17, 2006 notified five different public utilities (El Paso Electric Company, ALLETE, Inc., Illinois Power Company, Oklahoma Gas and Electric Company, and Select Energy, Inc.) of the Commission s intent to commence for each a limited scope audit of [the public utility s] compliance with Commission rules and regulations concerning interlocking positions and other Commission regulations. . . . The audit objective is to determine whether officers and directors of [the public utility] holding interlocking positions have complied with the Commission s interlocking directorate requirements under section 305(b) and (c) of the [FPA] 13 and [the Commission s Regulations]. The letters indicate that the scope of the audit is to cover interlocking positions held during calendar year 2004.14
12 13
16 U.S.C. 825d(b) (2004).
See, e.g., Letter from Janice Garrison Nicholas, Chief Accountant and Director, [FERC] Division of Audits and Accounting to Ms. Cheryl W. Grise, Select Energy, Inc. (Docket No. FA06-6-000) (Feb. 17, 2006).
14
Id.
CHAPTER 3 (CIVIL AND CRIMINAL PENALTIES) GERALD RICHMAN FERC Orders Give Some Comfort on the Issue of Duplicative Sanctions for the Same Conduct In describing FERC s enhanced penalty authority as a result of EPAct 2005, we discussed in Handbook Chapter 3 a scenario whereby a single action could violate multiple regulatory requirements, triggering a separate potential violation with respect to each provision violated (further multiplied by the number of violation days). However, subsequent FERC orders promulgating the agency s new market manipulation rules 15 and revising and recodifying the prior Market Behavior Rules16 discussed in more detail infra in the update for Chapter 9 indicate that the Commission will not automatically engage in such double counting. Among other things, these orders recognized that Market Behavior Rule 2 essentially was aimed at categories of market manipulation and thus was duplicative of the new market manipulation rules. 17 The Commission thus determined to rescind Market Behavior Rule 2. However, because the new Market Behavior Rules became effective on January 22, 2006, and the rescission of Market Behavior Rule 2 18 became effective on February 16, 2006, there was a period of actual overlap. But FERC emphasized that it would not seek duplicative sanctions for the same conduct in the event that conduct violates both Market Behavior Rule 2 and the new market manipulation rules.19 At the same time, the Standards of Conduct for Transmission Providers separately (a) prohibit disclosure of non-public transmission information to an Energy Affiliate and (b) mandate independent functioning between Transmission Providers and Energy Affiliates. It is still not clear whether conduct that violated both these requirements might not be treated as separate violations for the purpose of assessing civil penalties. In that regard, it should be recalled that in the Enforcement Policy Statement the Commission previously had indicated that it would not seek duplicative sanctions for the same conduct in the event it violates both the then-proposed market manipulation rule and the Market Behavior Rules, but [i]n other contexts, 20 violations of more than one statute, order, rule, or regulation may result in separate penalties.
15
Prohibition of Energy Market Manipulation, Order No. 670, 114 FERC 6 1 , 0 4 7( 2 0 0 6 ) ( O r d e r N o .
6 7 0 ) . Conditions for Pub. Util. Market-Based Rate Authorization Holders, Order No. 674, 114 FERC 61,163 (2006); Order Revising Market-Based Rate Tariffs and Authorizations, 114 FERC 61,165 (2006) ( Revision Order ) ; Amendments to Codes of Conduct for Unbundled Sales Service and for Persons Holding Blanket Mktg. Certificates, Order No. 673, 114 FERC 61,166 (2006).
17 18 19 20 16
See Order No. 670, 114 FERC 61,047 at P 59; Revision Order, 114 FERC 61,165 at P 22. Revision Order, 114 FERC 61,165 at P 21. Order No. 670, 114 FERC 61,047 at P 59; Revision Order, 114 FERC 61,165 at P 10. Enforcement Policy Statement, 113 FERC 6,1068 at P 14.
CHAPTER 9 (MARKET BEHAVIOR RULES) CHERYL M. FOLEY FERC Issues New Anti-Manipulation Rules and Repeals and Codifies Its 2003 Market Behavior Rules FERC s new market manipulation rules, as implemented by Order No. 670, add a new Part 1c to the Commission s general regulations. Sections 1c.1(a) and 1c.2(a) prohibit market manipulation, respectively, in jurisdictional natural gas sales and transportation markets and in jurisdictional electric sales and transmission markets. In language nearly identical to Rule 10b521 adopted to implement Section 10(b) of the Securities and Exchange Act of 1934 ( Exchange 22 Act ), these sections make it unlawful for any entity: directly or indirectly, in connection with the purchase or sale of natural gas [or electric energy] or the purchase or sale of transportation [or transmission] services subject to the jurisdiction of the Commission, (1) to use or employ any device, scheme or artifice to defraud, (2) to make any untrue statement of material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, or (3) to engage in any act, practice or course of business that would operate as a fraud or deceit on any entity. Sections 1c.1(b) and 1c.2(b) each preclude private rights of action arising out of new Part 1c, as required under EPAct 2005. Additionally, on February 16, 2006, the Commission rescinded existing Market Behavior Rules 2 and 6 in market-based rate tariffs and natural gas blanket certificates, effective upon publication of the Revision Order in the Federal Register.23 It also rescinded the procedural and remedial provisions of Appendix B and codified in separate, generally applicable regulations, Rules 1, 3, 4, and 5.24 Additionally, it issued a separate notice of proposed rulemaking to expand the record-keeping requirements of Rule 5 from three to five years.25
21 22 23 24 25
17 C.F.R 240.10b-5 (2005). 15 U.S.C. 78j(b). Revision Order, 114 FERC 61,165 at P 1. Id. at P 2.
Revisions to Record Retention Requirements for Unbundled Sales Service, Persons Holding Blanket Mktg. Certificates, and Pub. Util. Market-Based Rate Authorization Holders, Notice of Proposed Rulemaking, 114 FERC 61,164 (2006).
In repealing Rule 2, the Commission found, in light of the new anti-manipulation rules of Order No. 670, that continuation of Rule 2 would cause regulatory uncertainty and confusion, and that its repeal would ensure that all market participants would be held to the same standards.26 It further found that Rule 6 was duplicative and unnecessary and that, with the elimination of the Market Behavior Rules as tariff and certificate conditions, the procedural and remedial rules were no longer applicable.27 As a result of the above actions, Order No. 670 now constitutes the sole rule relating to market manipulation. For the most part, Order No. 670 adopts as final the same language proposed in the Commission s notice of proposed rulemaking.28 However, in its discussion in the preamble to the Order, the Commission clarified several issues raised in industry comments, particularly as to the wholesale applicability of securities law under Rule 10b-5, from which the new language was virtually copied. Although the Commission reiterated its belief that the wealth of law that has been developed under Rule 10b-5 will guide it in its administration of the new anti-manipulation rules and help provide industry clarity, it acknowledged in response to many comments that a wholesale overlay of securities law is not appropriate for its regulation of the energy industry under the NGA and the FPA. The Commission therefore indicated its intent to decide on a caseby-case basis whether it is appropriate to adopt securities law precedents to specific energy 29 industry facts, circumstances, or situations. The Commission further acknowledged that its duty to protect consumers under the NGA and FPA is not through a regime of disclosure as compared to regulation under the Exchange 30 Act. With respect to the disclosure requirements of sections 1c.1(a)(2) and 1c.2(a)(2), the Commission explained that the rules do not create any new affirmative duty to disclose, absent 31 some tariff requirement or Commission directive mandating disclosure. It assured market participants that they are not required under the new rules to disclose sensitive strategic or proprietary information that would weaken their bargaining position. Although the rules create no new affirmative duty to disclose, the Commission explained that, if a party voluntarily provides information or if material information otherwise required to be provided is misrepresented or omitted, such that the information that is provided is materially misleading, such omission or misrepresentation could constitute a violation of the rules.32 The Commission
26 27 28
Revision Order, 114 FERC 61,165 at P 1. Id. at P 46.
T h e o n l y c h a n g e m a d e i s a d o p t i o n o f t h e w o r d e n t i t y i n1 c . 1 ( a ) ( 3 ) a n d 1 c . 2 ( a ) ( 3 ) i n t h e f i n a l r u l e i n l i e uo f t h e w o r d p e r s o n , as proposed in the notice, in order to broaden the protected class. Order No. 670, 114 FERC 61,047 at P 76.
29 30 31 32
Id. at P 31. Id. at PP 32, 36. Id. at P 35. Id. at P 41.
also clarified that mere puffery (such as predictions of future business expectations) does not 33 violate the rules. Addressing bilateral contracts, the Commission indicated that it would generally not apply the new rules to bilateral contract negotiations unless, on a case-by-case basis, a material misrepresentation or omission occurred in or had an effect on jurisdictional transactions. 34 Although the Commission s explanation of its approach to bilateral contracts is not entirely clear, it appears that the Commission s primary goal under the new rules is to protect markets, not individual contracts. It stated its expectation that state and federal contract law would continue to apply to bilateral negotiations and contracts, including claims of fraud in the inducement, and that parties should continue to resolve these types of disputes without Commission involvement.35 The Commission stated that it will act under the rules when an entity violates section 1c.1(a)(1)-(3) or 1c.2(a)(1)-(3), with the requisite scienter, in connection with a jurisdictional electric or natural gas sales transaction or transmission/transportation service. Although the Commission rejected arguments to eliminate sections 1c.1(a)(3) and 1c.2(a)(3) or to revise the language of the final rules to specify that intent or scienter is required for any violation of the rules, it did clarify in the preamble that there can be no violation of the Final Rule, or any of its 36 sections, absent a showing of the requisite scienter. Further clarifying the elements of a violation, the Commission defined fraud generally as involving an action, transaction, or conspiracy for the purpose of impairing, obstructing or defeating a well-functioning market and it explained that fraud will be determined on a case37 by-case basis. Materiality will also be determined on a case-specific basis. A fact will be defined as material if there is a substantial likelihood that a reasonable market participant would consider it in making its decision to transact because the material fact significantly altered the total mix of information available as determined at the time of the statement or omission, not in hindsight.38 As to scienter, in addition to knowing and intentional misconduct, the Commission adopted securities law precedent holding that recklessness also satisfies the scienter requirement.39 In concluding that a violation requires a showing of scienter, the Commission cited case law that interprets Rule 10b-5 as proscrib[ing] a type of conduct quite different than 40 negligence.
33 34 35 36 37 38 39 40
Order No. 670, 114 FERC 61,047 at P 42. Id. at P 41. Id. at P 37. Id. at P 45. Id. at P 50. Id. at P 51. Order No. 670, 114 FERC 61,047 at P 53. Id. at P 52 & n.107.
The third element of a violation (an act, transaction or conspiracy in connection with a jurisdictional transaction) relates to the scope and applicability of the new rules, as determined by the Commission in response to multiple industry comments. In its discussion in the preamble, the Commission explained that it interprets the Final Rule as prohibiting any entity, including 41 any person or form of organization, regardless of its legal status, function or activities, from engaging in manipulation (as defined by the Final Rule) in connection with a jurisdictional sale or transportation of natural gas or a jurisdictional sale or transmission of electric energy. In taking this statutory interpretation of the governing language in EPAct 2005, the Commission expressly disavowed applicability of the Rule to non-jurisdictional transactions, such as first sales of imported natural gas, intrastate sales of electric energy, retail sales of electric energy or 42 energy sales by governmental entities. However, the Commission broadly construed the in connection withlanguage of both the statute and the rules to encompass situations in which there is a nexus between the 43 fraudulent conduct of an entity and a jurisdictional transaction. Whereas the Commission disclaimed any intent to convert every act of fraud into a violation of the Final Rule, it stated that there would be a violation if an entity acted intentionally or recklessly to affect a jurisdictional transaction. The Commission cited, as an example of a violation, a situation where an entity engaging in an otherwise non-jurisdictional transaction in a jurisdictional organized market, such as an RTO/ISO single price auction, acted intentionally or with recklessness to affect the auction price applicable to all market participants.44 The Commission rejected requests to apply the rules only to instances of market manipulation. Instead it stated its intent to police all forms of fraud and manipulation that affect natural gas and electric energy transactions and activities that the Commission is charged with 45 protecting. The Commission confirmed that actions taken consistent with safe-harbors under the (now repealed) Market Behavior Rules would not constitute violations of Order No. 670.46 It also expressly stated that the specific acts of manipulation set forth in Market Behavior Rule 2 (wash trades, transactions predicated on submission of false information, artificial congestions and collusion for the purpose of market manipulation) would also constitute violations of the new anti-manipulation rules. Similarly, it held that actions or transactions undertaken in conformity with the market rules of a Commission-approved ISO or RTO are presumptively not fraudulent.47
41 42 43 44 45 46 47
Id. at P 18. Id. at P 20. The Commission also disclaimed applicability of the rule to oil pipelines. Id. at P 24. Id. at P 22. Id. Order No. 670, 114 FERC 61,047 at P 25. Id. at P 67. Id. at P 59.
The Commission declined to adopt the procedural provisions of the Market Behavior Rules, including the ninety-day limit on the filing of complaints, as part of the new antimanipulation rules. The Commission indicated that it would use its prosecutorial discretion as to whether to pursue complaints, in light of all of the circumstances, including the time elapsed since the occurrence of the alleged violation. It also stated, however, that it would use the general 5-year federal statute of limitations in applying civil penalties. 48 The Commission further held that its authority under EPAct 2005 to enforce prohibitions against market manipulation is independent of other provisions in the NGA or the FPA. 49 It determined not to adopt new procedural provisions, and, instead, explained its decision to use existing rules, such as Rule 206,50 with its requirements as to the specificity of a pleading, and the requirements under Order No. 66351 to include a separate Statement of Issues, to govern its processing of a complaint.52 It also stated that its enforcement authority under EPAct 2005 was not limited to prospective-only remedies, and it rejected any suggestion that it could not order penalties, such as disgorgement of profits, after the occurrence of an act of manipulation.53 Finally, the Commission clarified that the new anti-manipulation rules are not intended to modify or supersede its Policy Statement on Natural Gas and Electric Price Indices. 54 It encouraged market participants to engage in price reporting and confirmed that participants would not be penalized for inadvertent errors.55
48 49 50 51
Id. at P 63. Id. at P 70. 18 C.F.R. 385.206 (2005).
Revision of Rules of Practice and Procedure Regarding Issue Identification, Order No. 663, 112 FERC 61,297 ( 2 0 0 5 ) ( O r d e r N o . 6 6 3 ) .
52 53 54 55
Order No. 670, 114 FERC 61,047 at PP 70 and 80. Id. at 72. Policy Statement on Natural Gas and Elec. Price Indices, 104 FERC 61,121 (2003). Order No. 670, 114 FERC 61,047 at P 78.
CHAPTER 12 (INTERLOCKING DIRECTORATE RULES) KATHRYN KAVANAGH BARAN Interlocking Directorate Audits As discussed supra in connection with operational audits, on February 17, 2006, FERC s OMOI notified five different public utilities of the Commission s intent to commence for each a limited scope audit of [the public utility s] compliance with Commission rules and regulations 56 concerning interlocking positions and other Commission regulations. . . . Other Developments The Commission s Order No. 66457 moved another step closer to finality on February 16, 2006 when the Commission denied the request for rehearing and stay that had been filed by Morgan Stanley Capital Group Inc., Merrill Lynch Commodities, Inc. and Merrill Lynch Capital Services, Inc.58 Morgan Stanley/Merrill Lynch have until April 17, 2006 to petition for appellate review of Order Nos. 664 and 664-A. The Commission s order denying rehearing restated the Commission s determination to amend Part 45 of the Commission s regulations to clarify that individuals seeking Commission authorization to hold interlocking positions must obtain such authorization from the Commission prior to holding the interlocking positions.59 Order No. 664 also had amended the regulations to require that an individual filing an informational report for automatic authorization under section 45.9 of the Commission s regulations must file such informational report prior to holding the interlocking positions and that the informational report must include a statement or affirmation that the individual has not yet assumed the duties or responsibilities of the interlocking position for which the automatic authorization is sought.60 Finally, in Order No. 664, the Commission indicated that it would henceforth subject officers and directors of power marketers (which in the past had been granted market-based rate authority, and thus, as to their officers and directors, waiver of the full requirements of Part 45) to the same requirements under Part 45 of the Commission s regulations as officers and directors of traditional public utilities. 61 With respect to an individual who currently is authorized to hold interlocking positions, however, that individual will not need to re-file under the full requirements of Part 45 to continue to hold such
56 57
See note 13 supra.
Comm nA u t h o r i z a t i o nt oH o l dI n t e r l o c k i n gP o s i t i o n s , Order No. 664, 112 FERC 61,298 (2005) ( O r d e r N o . 6 6 4 ) . S e eC o m m nA u t h o r i z a t i o nt oH o l dI n t e r l o c k i n gP o s i t i o n s , Order No. 664-A, 114 FERC 61,142 ( 2 0 0 6 ) ( O r d e r N o . 6 6 4 -A ) .
59 60 61 58
See Order No. 664, 112 FERC 61,298 at P 1. Id. at P 2. Id. at PP 34, 35.
12
interlocking positions (unless and until, of course, that individual assumes different or additional interlocking positions), according to the Commission.62 Errata Handbook Chapter 12, Interlocking Directorate Rules, incorrectly indicated that EPAct 2005 gave to FERC authority to assess civil penalties for each day that a person or public utility failed to comply with FPA Sections 305(b) and 305(c). The Commission s civil penalty authority, as correctly described in Handbook Chapter 3, Civil and Criminal Penalties, applies only to Part II of the FPA, not to the Interlocking Directorate Rules, which are in Part III of the FPA. Thus, the Commission s sole penalty authority for enforcing Interlocking Directorate Rules is found in FPA section 316(a). That is, if a person has been convicted of willfully and knowinglyfailing to obtain prior authorization for an interlocking position proscribed under Section 305(b) or filing reports required under Section 305(c) of the FPA, the person may be punished by a criminal fine of up to $1,000,000 or imprisonment for up to five years, or both.63 In addition, violators may be subject to an additional $25,000 per day fine for a continuing violation.64
62 63 64
Id. at P 36. 16 U.S.C. 825-1(a) (2005). Id. at 825-1(b).
Chapter 14 (The Regulation of Qualifying Facilities Under PURPA) DONNA M. FRANCESCANI On February 2, 2006, FERC issued a final rule 65 amending its regulations governing small power production and cogeneration pursuant to section 1253 of EPAct 200566 and section 210 of the Public Utility Regulatory Policies Act of 1978 ( PURPA ). 67 Order No. 671 is described below. Of particular note, any existing Qualifying Facility ( QF ) that has not to date filed a notice of self-certification or applied for FERC certification must do so by April 17, 2006.68 In addition, FERC has clarified that a QF which is no longer eligible for exemption from FPA section 205 should make any required section 205 filings by March 17, 2006,69 in order to be granted a waiver of the requirement that proposed rates be submitted at least 60 days prior to their proposed effective date. Elimination of Ownership Criteria As expected, Order No. 671 eliminated the former limitation on the ownership of a QF by an electric utility or electric utility holding company. 70 Thus, there is no longer any such limitation, either for existing QFs or for new QFs. It should be noted, however, that there still is an ownership disclosure requirement in FERC s Form 556. Thus, an applicant must identify all 71 utility owners. Furthermore, the revised Form 556 still requires disclosure of the percentage of ownership held by any electric utility or electric utility holding company, or any persons 72 owned by either . . . . FERC has also clarified that removal of the ownership prohibition removes the bar to a QF selling non-QF electric energy. 73 Thus, a QF may now sell non-QF electric energy without losing its QF status. However, as discussed below, any non-QF electric energy sold by a QF must be sold pursuant to the FPA and such sales are not exempt from FPA sections 205 and 206.
See Revised Regulations Governing Small Power Production and Cogeneration Facilities, Order No. 671, 114 FERC 61,102 (2006) ( O r d e r N o . 6 7 1 ) , clarified, 114 FERC 61,128 (2006) ("Order on Clarification"). To date, one group of non-utility QFs has requested rehearing and the Commission has yet to act on that request. The notice of proposed rulemaking that preceded the Final Rule is discussed in the PURPA Chapter of the Handbook. See Revised Regulations Governing Small Power Production and Cogeneration Facilities, Notice of Proposed Rulemaking, 113 FERC 61,020 (2005) ( October 2005 NOPR ).
66 67 68 69 70 71 72
65
EPAct 2005 1253, 119 Stat. 594, 967-70. 16 U.S.C. 824a-3. See infra n.91. See infra n.98. Order No. 671, 114 FERC 61,102 at P 107. Id. at P 110 (emphasis in original).
Revised Regulations Governing Small Power Production and Cogeneration Facilities, 71 Fed. Reg. 7852, 7867 (Feb. 15, 2006) (to be codified at 18 C.F.R. 131.80) (Revised Form 556).
73
Order No. 671, 114 FERC 61,128 at P 101.
14
Cogeneration Facilities Under EPAct 2005, unless a new cogeneration facility is 5 MW or smaller, it will be subject to more exacting standards and requirements for qualification than existing qualifying cogeneration facilities. An existing qualifying cogeneration facility is one that was a QF on August 8, 2005 (when EPAct 2005 was signed into law) or one that filed a self-certification or application for Commission certification prior to February 2, 2006 (when Order No. 671 was issued).74 FERC has explained that there is a rebuttable presumption that an existing QF does not become a newcogeneration facility merely because it files for recertification, as long as the facility does not undergo changes so significant as to merit a finding that the facility should 75 be considered new. The Productive and Beneficial Thermal Use Standard
An applicant seeking certification of a new cogeneration facility is required to demonstrate that the thermal output of the cogeneration facility is used in a productive and 76 beneficial manner. Form 556 has been revised to require a showing that the facility meets this new standard, and the initial burden of demonstrating compliance is on the new cogeneration applicant. 77 FERC will begin its analysis by determining if the new cogeneration facility s 78 thermal output is presumptively useful. [I]f certain uses of thermal output were previously considered presumptively useful under the prior regulations and case precedent, they will be considered productive and beneficial uses, but those who oppose certification will have the opportunity to demonstrate that the thermal use is not, in fact, being used in a productive and 79 beneficial manner. Thus, the presumption of usefulness is no longer irrebutable. In determining whether a facility s thermal output is used in a productive and beneficial manner, FERC will consider various factors including whether the product produced by the thermal energy is needed and whether there is a market for the product.80 There is no bright line test: a thermal use that might be productive and beneficial in one market might not be in another.81 For new cogeneration facility s that are 5 MW or smaller, FERC will apply a rebuttable 82 presumption of usefulness.
74
Id. at P 115; 71 Fed. Reg. at 7868 (to be codified at 18 C.F.R. 292.205(d)).
75 Order No. 671, 114 FERC 61,128 at P 115. For example, a 50 MW facility that is converted into a 3 5 0 MW f a c i l i t y m i g h t b e d e e m e d t o b e a n e w c o g e n e r a t i o n f a c i l i t y . Id. 76 77 78 79 80 81 82
Id. at P 17. Id. at P 18. Id. at P 17. Id. at P 25. Id. at P 17. Id. at P 19. Id. at P 26.
The Fundamental UseStandard
An applicant seeking certification of a new cogeneration facility must also demonstrate that the facility s electrical, thermal, and chemical output . . . is used fundamentally for industrial, commercial, or institutional purposes and is not intended fundamentally for sale to an 83 electric utility . . . . To implement this requirement, FERC will assess new cogeneration facilities on a case-by-case basis. 84 However, FERC has also adopted a safe harbor standard. New cogeneration facilities seeking QF status will be required to demonstrate that at least 50 percent of the aggregated annual energy output of the facility is to be used for industrial, commercial, residential or institutional purposes and not for sale to an electric utility. 85 If a facility fails to meet the safe harbor standard, FERC will not certify the facility unless the applicant can demonstrate that the facts and circumstances warrant certification based upon consideration of the technological, efficiency, economic, and variable thermal energy requirements, as well as state laws applicable to sales of electric energy from a qualifying facility to its host facility, as expressly set forth in EPAct 2005.86 As with the productive and beneficialthermal use standard, FERC will apply a rebuttable presumption that new cogenerators of 5 MW or smaller meet the fundamental use 87 standard. The Continuing ProgressStandard
Pursuant to EPAct 2005, FERC is required to issue rules to ensure continuing progress 88 in the development of efficient electric energy generating technology. In Order No. 671, FERC departed from the proposal it had announced in the NOPR and explained that its implementation of the productive and beneficial and fundamental use standards was sufficient to ensure continuing progress in the development of efficient energy generating 89 technology . . . . Accordingly, applicants for certification of new cogeneration facilities do not need to provide a description of how a particular technology will contribute to continuing progress in the development of efficient energy generating technology. In addition, FERC determined that it would retain the existing operating and efficiency standards for new oil and gas cogeneration facilities and not impose new efficiency standards for new coal-burning 90 cogeneration facilities at this time.
83 84 85 86 87 88 89 90
Id. at P 27. Id. at P 50. Id. at PP 50-51. Id. Id. at P 60. Id. at P 62 (quoting Section 210(a)(1)(A)(iii) of PURPA as amended by EPAct 2005). Id. at P 68 (quoting Section 210(a)(1)(A)(iii) of PURPA as amended by EPAct 2005). Id. at P 69.
Mandatory Certification or Self-Certification
After considering eliminating the option of self-certification for new cogeneration facilities, FERC determined it is appropriate to retain self-certification as an option. 91 However, FERC made several notable changes to its existing regulations. First, under the previous regulations there was no requirement that a facility make any filing in order to satisfy the requirements for QF status. Specifically, 18 C.F.R. 292.207 provided that [a] small power production facility or cogeneration facility that meets the 92 applicable criteria established in 292.203 is a qualifying facility. As a result of the new amendments, 18 C.F.R. 292.203 which previously did not include any filing requirement now expressly requires that a facility claiming QF status must file either a notice of selfcertification or an application for Commission certification.93 Any existing QF that has not done so to date must do so by April 17, 2006.94 In addition, notices of self-certification and selfrecertification for new cogeneration facilities are now required to be published in the Federal Register.95 Finally, FERC has amended its QF regulations to make clear that it can, on its own motion, revoke the QF status of self-certified and self-recertified QFs.96 Exemptions from FPA 205 and 206
Under the Commission s prior regulations, QFs (other than non-geothermal small power production facilities between 30 and 80 MW) were exempt from sections 203, 205, 206, 208, 301 and 304 of the FPA.97 Order No. 671 does away with the QF exemptions from sections 205 and 206 of the FPA, except for QF sales made pursuant to a state regulatory authority s 98 implementation of PURPA. The elimination of exemptions from sections FPA 205 and 206 does not apply to existing contracts executed on or before March 17, 2006.99 In addition, all sales of QF power by QFs 20 MW or smaller remain exempt from FPA sections 205 and 206.100 The elimination of the exemption from sections 205 and 206 means that some QFs that were previously exempt will now need to make section 205 filings. The Commission has stated
91 92 93
Id. at P 78. 18 C.F.R. 292.207 (2005) (emphasis added). Order No. 671, 114 FERC 61,102 at P 82; see also 71 Fed. Reg. at 7861 (to be codified at 18 C.F.R. Order No. 671, 114 FERC 61,102 at P 82. Id. at P 80; see also 71 Fed. Reg. at 7868 (to be codified at 18 C.F.R. 292.207). Id. at P 79. Id. at P 94. Id. at P 99. Id. at P 97; see also 71 Fed. Reg. at 7868 (to be codified at 18 C.F.R 292.601(c)(1)). Id. at P 98.
292.203).
94 95 96 97 98 99 100
that if QFs make any required section 205 filings by the effective date of Order No. 671, March 17, 2006, it will grant waiver of the section 205(d) requirement that proposed rates be submitted at least 60 days prior to their proposed effective date.101 With respect to section 203 of the FPA, QFs remain exempt from the filing requirements of section 203(a)(i), but a QF is considered an electric utility company for purposes of section 203(a)(2).102 QFs are not exempt from the newly added FPA sections of 220, 221, and 222.103 In its amended PURPA regulations, the Commission expressly exempts QFs (other than non-geothermal small power production facilities greater than 30 MW) from the definition of e l e c t r i c u t i l i t y c o m p a n y as defined in PUHCA 2005.104
101 102 103 104
Order on Clarification, 114 FERC 61,128 at P 3. Id. at P 102. Id. at P 103.
Order No. 671, 114 FERC 61,102 at P 92; see also 71 Fed. Reg. at 7869 (to be codified at 18 C.F.R. 292.602). It should be noted that PUHCA 2005 expressly excludes certain other types of entities from the de f i n i t i o n o f e l e c t r i c u t i l i t y c o m p a n y , b u t n o t Q F s .
CHAPTER 16 (RELIABILITY) DAVID J. HILL FERC s New Reliability Rule Raises Expanded Compliance Issues The EPAct 2005 fundamentally changed the system for ensuring reliability of the national power grid. Title XII of the statute created a new section 215 of the FPA,105 entitled Electric Reliability. In enacting this landmark provision, Congress determined that the historical reliance on voluntary compliance by participants in the electric industry with industry reliability requirements is no longer sufficient. Section 215 grants the Commission the authority to designate an E l e c t r i c R e l i a b i l i t y O r g a n i z a t i o n( ERO ) to establish mandatory, Commissionapproved, enforceable electricity reliability standards, subject in each case to FERC s review and approval. Specifically, FERC will certify, subject to its ongoing oversight, a single ERO to oversee the reliability of the United States portion (i.e., excluding Alaska and Hawaii) of the interconnected North American Bulk-Power System. The ERO will be responsible for developing and enforcing the mandatory Reliability Standards, which will apply to all users, owners and operators of the Bulk-Power System. The Commission has the authority to approve all ERO actions, to order the ERO to carry out its responsibilities under these new statutory provisions, and it also may independently enforce Reliability Standards. On September 1, 2005, FERC issued a Notice of Proposed Rulemaking ( NOPR ) to implement section 215.106 On February 3, 2006, FERC issued Order No. 672 to carry out its reliability obligations under this statute.107 This massive order 377 pages in all focuses on the structures and procedures that section 215 directs the Commission to undertake with regard to the formation and functions of the ERO and related Regional Entities (which may be similar to the current regional reliability councils), and Regional Advisory Bodies (voluntary organizations among states). Order No. 672, including its extensive discussions, e.g., of ERO governance and funding provisions and procedures regarding the adoption and implementation of individual reliability standards, is not fully summarized here. Instead, we focus on the principal elements of this new regulatory regime. All Bulk-Power System users, owners, and operators would be well-advised to keep abreast of and actively participate in this process and to take steps now to ensure that reliability measures become part of their comprehensive compliance programs.
105 106
16 U.S.C. 824o (2005).
Rules Concerning Certification of the Elec. Reliability Org.; and Procedures for the Establishment, Approval, and Enforcement of Elec. Reliability Standards, Notice of Proposed Rulemaking, 112 FERC 61,239 ( 2 0 0 5 ) ( N O P R ) . Rules Concerning Certification of the Elec. Reliability Org.; and Procedures for the Establishment, Approval, and Enforcement of Elec. Reliability Standards, Order No. 672, 114 FERC 61,104 (2006) ( O r d e r N o . 6 7 2 ) . T h e r e g u l a t i o n s w i l l b e c o d i f i e d a s a n e wP a r t 3 9 o f t h e C o m m i s s i o n s r u l e s a n d r e g u l a t i o n s .
107
19
The Key Structural Components of the New Rule In brief, Order No. 672 covers the following subject areas: 1) The criteria that an entity must satisfy to qualify to be the ERO, which the Commission will certify as the sole organization that will propose and enforce Reliability Standards for the Bulk-Power System in the United States, subject to Commission approval. (It is likely that the North American Reliability Council ( NERC ), which currently develops and implements voluntary reliability standards, will be selected as the ERO.) The procedures under which the ERO may propose new or modified Reliability Standards108 for Commission review, including provisions for reasonable notice and opportunity for public comment, due process, openness, and balance of interests.109 A process for the timely resolution of any conflict between a Reliability Standard and a Commission-approved tariff or order. A process for resolution of an inconsistency between a state action and a Reliability Standard. The regulations pertaining to the funding of the ERO to guarantee its independence and ability to carry out its responsibilities. The procedures governing enforcement actions by the ERO, a Regional Entity, or the Commission.110
2)
3) 4) 5) 6)
T h e t e r m Reliability Standard i s d e f i n e di nO r d e r N o . 6 7 2w i t hr e f e r e n c e t os e c t i o n2 1 5o f t h e F P Aa s a requirement, approved by the Commission under the instant proposed regulation, to provide for Reliable Operation of the Bulk-Power System. The term includes requirements for the operation of existing Bulk-Power System facilities, including cybersecurity protection, and the design of planned additions or modifications to such facilities to the extent necessary to provide for Reliable Operation of the Bulk-Power System. The term does not include any requirement to enlarge such facilities or to construct new transmission capacity or generation capacity.O r d e r N o . 6 7 2 , 1 1 4 F E R C 6 1 , 1 0 4 a t P 6 6 ( e m p h a s i s a d d e d ) . Under Order No. 672, the ERO must submit each proposed Reliability Standard to FERC for approval, and only a Reliability Standard approved by the Commission will be enforceable under section 215. Pursuant to section 1241 of EPAct 2005, the Commission will allow recovery of all costs prudently incurred to comply with the Reliability Standards. It should also be noted that the statute explicitly bars preemption of any authority of any state to take action to ensure the safety, adequacy and reliability of electric service within the state, as long as such action is not inconsistent with a Reliability Standard. See id. at P 815. Order No. 672 sets forth various elements of the enforcement process, including (1) a compliance program that includes proactive enforcement audits to determine if users, owners and operators are complying with Reliability Standards; (2) investigations of alleged violations of Reliability Standards and the prompt notification to FERC of such investigations and their disposition; and (3) the assessment of penalties (non-monetary or monetary), subject to Commission review. See id. at PP 45, 450-638.
110 109
108
20
7)
The criteria under which the ERO may enter into an agreement to delegate authority to a Regional Entity for the purpose of proposing Reliability Standards to the ERO and enforcing Reliability Standards; The regulations governing the issuance of periodic reliability reports by the ERO that assess the reliability and adequacy of the Bulk-Power System in North America. 111 The procedures for the establishment of Regional Advisory Bodies (i.e., voluntary organizations of states) that may provide advice to the Commission, the ERO or a Regional Entity on matters of governance, applicable Reliability Standards, the reasonableness of proposed fees within a region, and any other responsibilities requested by the Commission. What Happens Next?
8)
9)
Various parties have requested clarification and/or rehearing of Order No. 672, mainly on limited issues. Although such requests can typically delay the adoption of a final order indefinitely, FERC has shown great dedication in promptly discharging its responsibilities under EPAct 2005 and is likely to do so here. Once there is a final order, and absent a stay pending any appeal, ERO candidates (NERC and perhaps others) have 60 days to file an application, which will be subject to public comment. There is broad support for the reliability provisions of the Act, and the requests for clarification and/or rehearing do not appear to have raised the kind of fundamental objections that could keep the Final Rule in the courts for years. This is not to say that any ERO proposal will be free of controversy, however. For all it did decide, Order No. 672 imposes heavy burdens on ERO applicants to deal with (and address in their applications) the myriad of details still to be decided on virtually every one of the subject areas described above. Thus, the ERO application process could spark numerous debates within the industry, among state regulators, and the Commission itself about how such matters should be resolved before the ERO is designated and commences its substantive work. Compliance Aspects of the New Order Once substantive reliability standards are approved and implemented, the ERO and approved Regional Entities will be required to audit and enforce the approved standards. Order
As discussed above, new FPA section 215(a)(3) provides that the term Reliability Standard does not include any requirement to enlarge Bulk-Power System facilities or to construct new transmission capacity or generation capacity. In Order No. 672, however, the Commission concluded that this section does not preclude the ERO from obtaining information relating to resource adequacy for the purposes of making its required reports on the adequacy of the Bulk-Power System pursuant to new FPA section 215(g). See id. at P 806. Accordingly, section 39.11(b) of Order No. 672 requires the ERO to conduct assessments of the adequacy of the Bulk-Power System in North America and report its findings to the Commission and others. Further, the ERO may obtain pertinent information on resource adequacy from any user, owner or operator of the Bulk-Power System.
111
21
No. 672 includes a new section 39.7(a) that requires the ERO and Regional Entities to develop an audit program that provides for rigorous audits of compliance with Reliability Standards by 112 users, owners and operators of the Bulk-Power System. In support of this requirement, the Order places broad information disclosure requirements on each user, owner or operator of the Bulk-Power System. Order No. 672 s requirements are coupled with enforcement powers that grant the ERO and Regional Entities the authority to assess, subject to FERC review, monetary and nonmonetary penalties, which could be substantial for serious violations. 113 The ERO will have some discretion in applying such penalties, which, tracking FERC s own authority under Part II of the FPA, may be as high as $1 million per day per violation.114 FERC will have the ability to review and change or overturn penalties. Importantly, while FERC leaves to the ERO the task of proposing a framework for the ERO s audit and enforcement process, FERC strongly hinted that an enforcement regime consistent with FERC s recent Enforcement Policy Statement would be appropriate. 115 As described in a previous mailing, 116 the Enforcement Policy Statement seeks to reward strong compliance efforts with reduced penalties when infractions occur. It seems likely, therefore, that the same sort of considerations will apply to the ERO s enforcement efforts, thus making compliance with ERO rules a strong candidate for incorporation into electric utility compliance programs. Indeed, companies now engaged in organization of such compliance programs may wish to build in at least the framework for ERO compliance; some may wish to go further and actually establish a program for compliance with the current voluntary NERC Version 0.0 standards, which are likely to be the basis for the enforceable standards ultimately approved by FERC.
112 113 114 115
See id. at P 463. See, e.g., id. at PP 480-575. See id. at P 575.
See id. at P5 5 1& n . 1 5 3( [ A ] penalty must bear a reasonable relation to the seriousness of the violation. . . . For example, a violation by an entity with a weak compliance program may merit a larger penalty than a violation by an entity with a strong compliance program. ) ( c i t i n gEnforcement Policy Statement, 113 FERC 61,068 at PP 22-23); id. a t P5 6 1& n . 1 5 8( The Commission concludes that penalty guidelines, developed by the ERO and approved by the Commission, would provide a predictable, uniform and rational approach to the imposition of penalties. ) ( c i t i n g Enforcement Policy Statement). Skadden, Arps, Slate, Meagher & Flom, LLP, FERC, Seeking Compliance Culture, Links Penalties to Strength of Compliance Program (Nov. 3, 2005).
116
22
April 6, 2006
SKADDEN COMPLIANCE HANDBOOK UPDATE

ALERT FOR QFs: April 17, 2006 Filing Deadline
If you have any questions, please contact any of the following Compliance Team Members: Mike Naeve 202/371-7070
mnaeve@skadden.com
In the March 20, 2006 Skadden Compliance Handbook Update, we alerted readers to the upcoming deadline of April 17, 2006 for any existing QF 1 that has not to date filed a notice of self-certification or applied for certification from FERC to do so. As the April 17th deadline draws closer, we offer a reminder regarding this new regulatory requirement for maintaining a facility's QF status. On February 2, 2006, FERC issued Order No. 671, a Final Rule amending its regulations governing small power production and cogeneration pursuant to section 1253 of the Energy Policy Act of 2005 and section 210 of the Public Utilities Regulatory Policies Act of 1978.2 For purposes of this Alert, one amendment wrought by Order 671 is noteworthy. Under the previous regulations there was no requirement that a facility make any filing in order to satisfy the requirements for QF status. Specifically, 18 C.F.R. 292.207 provided th a t [ a ] s m a l l p o w e r p r o d u c t i o nf a c i l i t yo r c o g e n e r a t i o nf a c i l i t yt h a t 3 meets the applicable criteria established in 292.203 is a qualifying facility. Section 292.203, in turn, contained no express filing requirement for QF status. As a result of Order No. 671, Section 292.203 now expressly states that in order to claim QF status, a facility must either file a notice of self-certification or obtain FERC certification. 4 F u r t h e r m o r e , O r d e r6 7 1m a n d a t e st h a t [a]ny existing QF that has never filed either a notice of self-certification or an application for Commission certification, must do so within sixty (60) days of the date this 5 order is published in the Federal Register, to continue claiming QF status. Given the February 15, 2006 publication of Order 671, the filing deadline for QFs that have not to date self-certified or sought FERC certification is Monday, April 17, 2006.6
Bill Scherman 202/371-7060

wscherma@skadden.com
John Estes 202/371-7950

jestes@skadden.com
Glenn Berger 202/371-7920 gberger@skadden.com * * *
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum may be considered advertising under applicable state laws.
WWW.SKADDEN.COM
Please contact us with questions or for assistance in meeting this deadline.
3 4 5 6
Capitalized terms are defined as set forth in the Skadden Compliance Handbook Update. See Revised Regulations Governing Small Power Production and Cogeneration Facilities, O r d e r N o . 6 7 1 , ( F e b . 2 , 2 0 0 6 ) ( O r d e r N o . 6 7 1 ) ; O r d e r o n C l a r i f i c a t i o n , 114 FERC 61,128 (February 10, 2006). FERC issued a tolling order on March 27, 2006 on pending rehearing requests. 18 C.F.R. 292.207(a)(1)(i) (2005) (emphasis added). Order 671 at P 82. Id. See 18 C.F.R. 385.2007(a)(2) (computation of time when last day of time period is a Sunday).
We w o u ld b e p lea s ed to t a lk w ith y o u a b o u t o u r FE R C c o m p lia n ce p r a c tic e . Plea s e s e e th e in s id e fro n t c o v e r fo r co n ta ct in fo r m a tio n .
Skadden
Skadden
SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP 1440 NEW YORK AVENUE, N.W. WASHINGTON, DC 20005-2111 (202) 371-7000

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Energy Regulatory Compliance:

The Skadden Handbook

Key Compliance Team Members

Energy Regulatory Compliance: The Skadden Handbook

Compliance with FERC-Administered Statutes

Other Federal Agencies

Introduction The Growing Importance of Compliance Programs for Energy Companies

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Chapter 1 The Hallmarks of a Successful Compliance Program

Pub. L. No. 109-58, 119 Stat. 594 (2005).

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Enforcement Policy Statement at P 21.

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

Id. at P 22. Id.

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Id. at P 24. Id. Id. Id.

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

Id. F o r a d i s c u s s i o n o f c o o p e r a t i o n i n t h e c o n t e x t o f a F E R Ca u d i t o r i n v e s t i g a t i o n , see Chapter 2 of this Handbook.

U n i t e dS t a t e sS e n t e n c i n gC o m m n ,An Overview of the United States Sentencing Commission at 1-2, http://www.ussc.gov/general/USSCoverview.pdf.

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Enforcement Policy Statement at P 21.

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

See USSG 8B2.1(b)(2)(A).

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

See 18 C.F.R. 358.4(e)(6) (2005).

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

USSG 8B2.1 cmt. 4(B).

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

USSG 8B2.1 cmt. n.4(B) (emphasis added).

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM G. COMMUNICATION OF STANDARDS AND PROCEDURES

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

See U S S G8 B 2 . 1 ( b ) ( 4 ) ( r e q u i r i n g c o m p a n i e s t o t a k e r e a s o n a b l e s t e p s f o r o t h e r w i s e disseminating information appropriate to s u c h i n d i v i d u a l s r e s p e c t i v e r o l e s a n d r e s p o n s i b i l i t i e s ) .

Enforcement Policy Statement at P 22.

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

Enforcement Policy Statement at P 24.

See USSG 8B2.1(b)(5)(C).

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Enforcement Policy Statement at P 22. USSG 8B2.1(b)(5)(B).

HALLMARKS OF A SUCCESSFUL COMPLIANCE PROGRAM

Enforcement Policy Statement at P 24.

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Chapter 2 FERC Audits and Investigations

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

FERC AUDITS AND INVESTIGATIONS

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

FERC AUDITS AND INVESTIGATIONS

TO A FERC AUDIT OR INVESTIGATION

Id. at PP 47-49. Id. Id. at PP 50-51.

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

FERC AUDITS AND INVESTIGATIONS

See 18 C.F.R. 1b.20, 388.112.

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

See Enforcement Policy Statement, 113 FERC 61,068 at P 24.

FERC AUDITS AND INVESTIGATIONS

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

Id. at PP 7-9. Id. at P 8.

VIOLATIONS OF THE FEDERAL POWER ACT

Pub. L. No. 109-58, 119 Stat. 594 (2005).

16 U.S.C. 825o(a) (2004).

ENERGY REGULATORY COMPLIANCE: THE SKADDEN HANDBOOK

See id. 823b.