* Potentially the largest penalty imposed by FERC
* Commission granted extended powers after 2005 scandal
* Sets up potential precedent over "loss-leader" strategy
By Scott DiSavino and Jonathan Leff
WASHINGTON/NEW YORK, Oct 31 U.S. regulators
threatened to fine Barclays roughly $470 million to
settle allegations that the bank and four traders manipulated
California electricity markets, reviving the specter of a
sector-wide crackdown on energy trading.
It could possibly be the biggest penalty ever levied by the
Federal Energy Regulatory Commission (FERC), and potentially
exceeds the fine Barclays paid over the Libor bid-rigging
scandal that cost Chief Executive Robert Diamond his job.
The bank has 30 days to show why it should not be penalized
for an alleged scheme of manipulating physical electricity
prices at a loss in order to make profits in related positions
in the swaps market, a strategy known as a "loss-leader".
British bank Barclays said it would fight the agency, likely
setting up a landmark legal battle that could set a precedent
over whether the once-common trading ploy in commodity markets
is illegal or simply ill-advised.
It will have huge implications across the market, as the
FERC - - w hich won expanded powers to tackle manipulation in 2005
after the California power trading scandal and related Enron
meltdown -- pur sues similar investigations against companies
including BP and Deutsche Bank.
The FERC also said four of the company's power traders --
Daniel Brin, Scott Connelly, Karen Levine, and Ryan Smith --
have 30 days to show why they should not be assessed a total of
$18 million in civil penalties.
It said their activity accounted for nearly a quarter of all
trading in the next-day power market during the period, accruing
gains of an estimated $34.9 million. Bank documents showed how
the traders bragged about how they would "crap on" certain
markets to profit in other ones, the order shows.
Barclays "strongly disagreed" with the order, which it said
was "by nature a one-sided document, and does not reflect a
balanced and full description of the facts."
"We believe that our trading was legitimate and in
compliance with applicable law," Barclays spokesman Mark Lane
said in an email. "We have cooperated fully with the FERC
investigation, which relates to trading activity that occurred
several years ago. We intend to vigorously defend this matter."
The four traders left Barclays over the past five years for
reasons unrelated to the investigation, according to a source
familiar with the matter. The bank closed its Portland office in
2011 and effectively quit the Western power market this year.
It is the latest blow for Barclays, which has fired staff,
clawed back pay and taken other disciplinary action after being
fined $450 million by U.S. and British regulators over Libor.
New CEO Antony Jenkins, who took over at the end of July, is
in the middle of a review to change the bank's culture and lift
profitability. The changes are due to be unveiled in February.
Earlier on Wednesday, Barclays announced that the U.S.
Department of Justice and the Securities and Exchange Commission
were investigating whether it was complying with U.S. laws in
its ties with third parties who help it win or retain business.
The FERC order is tantamount to an indictment, suggesting
the issue may go to court after settlement talks were
unsuccessful, said Craig Pirrong, a University of Houston
professor and expert in energy trade regulation.
The order threatens to stir up memories of the California
power crisis, but the allegations involve a far more subtle
trading strategy that industry veterans say had been common in
global markets: using loss-making trades in benchmark physical
commodity markets in order to profit from derivatives positions.
The "loss leader" gambit had until recently been viewed as
outside the bounds of regulators, whose purview typically
covered either physical markets or derivatives, but rarely
both. Although the practice has diminished greatly in recent
years as regulators get tougher, many veterans fear that old
deals could come back to haunt them.
As well as the return of $34.9 million gains plus interest,
the commission is also seeking a $435 million civil penalty.
"Scary stuff," said one senior executive at a trading firm.
"Which I guess is the point."
The FERC first flexed its muscles earlier this year with a
record $245 million settlement with power company Constellation
Energy over similar allegations. Other agencies pursued larger
fines against power merchants after the California debacle.
"FERC is getting tougher," said Pirrong. He cautioned that
there are "factual and conceptual challenges" in proving
manipulation in court, but that isn't stopping the agency.
"It is going to town on this theory of manipulation, and I
would wager that any firm that traded both physical and
financial power is at risk of a similar FERC action," he said.
The FERC Office of Enforcement staff alleged Barclays
engaged in a coordinated scheme to manipulate trading at four
electricity trading points in the Western United States.
The order alleges that Connelly, hired in May 2006 to start
a North American power market desk, hired a team of traders who
ultimately came to dominate the market, making up 24 percent of
all next-day fixed-price trading on the IntercontinentalExchange
trading platform during the months in question.
The bank's "total market concentration" was as much as 58
percent and no less than 10 percent in any given month, it says.
It then engaged in "loss-generating trading of next-day
fixed-price physical electricity" at a number of key electricity
hubs in order to pay off positions in the swaps market, where
contracts are settled based on physical market prices.
The traders were aware that the trading was "likely
unlawful", and ignored the warning of the head of Americas
commodity trading Joe Gold, who "made clear the practice was
unacceptable", according to the FERC order.
Experts say one of the biggest challenges in winning any
manipulation cases is demonstrating that traders intentionally
engaged in a losing trade to make bigger profits.
But, just as recorded telephone conversations between
California power traders about driving up power prices for
" g randma Millie" proved damning a decade ago, the agency used
instant messages and emails to bolster its case.
Smith, for instance, described how he manipulated the Palo
Verde market, according to the FERC order, and the "NP light" --
or off-peak power ('light') in the North Path 15 (NP) market in
northern California in an attempt to "drive the SP light lower."
Levine asked colleagues to "keep the PV index up and the SP
daily index down" while she was on vacation.
Mike Masters, co-founder of Better Markets and a frequent
advocate for stronger rules, said it could be the "tip of the
iceberg" as regulators probe more deeply into commodities.
"It's a very significant fine and not just because of the
dollar amount. It also highlights how banks and swap dealers
were combining financial and physical positions in a predatory
way to manipulate commodity markets," he said.
"If it's happened in power markets you can be sure it was
also going on in crude oil and other markets like refined oil
products," Masters said.