- - A series of emails and instant messages between Barclays PLC traders -- peppered with colorful and obscene language -- is at the heart of federal energy regulators' effort to impose record fines over a complex plan to manipulate California power markets.
The U.S. Federal Energy Regulatory Commission on Wednesday proposed a total $470 million fine on Barclays -- the largest ever by the agency -- based in part on communications by four traders on its West Coast power desk. The trading activity took place over two years from late 2006.
The team of four traders -- veterans of power merchant Mirant, one of the companies that had been fined hundreds of millions of dollars after the California power scandal a decade ago -- exchanged messages explaining how they would "crap on" certain prices in one market to profit in another.
The traders are alleged to have manipulated power prices -- driving up or down physical power prices to make money with their financial swap positions. That is alleged to have caused losses for rival power traders of $139 million -- and netted the bank gains of $34.9 million.
Although there was no clear indication that the trading significantly increased or decreased power prices for customers, the allegations may reopen old wounds in a state where the 2001 scandal and related Enron collapse still smarts.
Ironically, the FERC, which is flexing its enforcement muscle after receiving expanded powers to tackle illicit trading in 2005, was tipped off to the activity after other players in the market called its enforcement hotline.
The FERC gave the bank 30 days to "show cause", or contest the fine, which includes disgorgement plus a $435 million civil penalty. Barclays has said it will "vigorously" fight the order.
The order focuses on a period between November 2006 and December 2008, when the then-Managing Director of North American Power, Scott Connelly, as well as Daniel Brin, Karen Levine and Ryan Smith sent a string of messages to each other and to traders and brokers outside the bank.
The Commission notified Barclays that it had begun the investigation of Barclays' Western U.S. power trading on July 3, 2007.
Brin, reached on his mobile phone, declined to comment. Efforts to reach the other traders named in the order, announced late on Wednesday, were unsuccessful.
The instant messages and emails -- often written in barely decipherable trader jargon -- outlined the plot to rig various Western power markets, reminiscent of the infamous conversation between Enron traders talking of driving up "Grandma Millie's" electricity bill during the 2000-2001 California crisis.
On November 3, 2006, Smith bragged to a colleague about how he had narrowed the spread between the South Path (SP) power region and the Palo Verde market by trading physical power on the InterContinentalExchange, the electronic exchange whose prices are used as a benchmark.
The intent was to influence the peak market price at Palo Verde, a trading location in Arizona that has a substantial amount of nuclear generation that can be sold into California. The pay-off would be in swap contracts that were settled based on that price, a strategy known as a "loss-leader".
Smith concluded: "(That) was fun. Need to do that more often."
He also said he was going to "crap on the NP light and it should drive the SP light lower" -- referring to the South Path power region covering Southern California and the North Path (NP) region in the north of the state. Light refers to off peak, overnight trading hours.
In another note, Brin indicated that he was "doing phy so i am trying to drive price in fin direction," -- meaning he was using the physical power market to drive up the value of his financial swap positions.
The FERC said the traders -- who face a total of $18 million in civil penalties -- accounted for nearly a quarter of the next-day power market during the two years in question.
According to the FERC, the Barclays team put together by Connelly made up an average of 24 percent of all next-day fixed-price trading, and as much as 58 percent in some months.
Exchanges, like ICE, will be critical to the FERC's allegations. Experts say the most difficult thing about winning a "manipulation" case is proving traders' intent to do so.
LOSE ON ONE TO WIN ON THE OTHER
As an example of the type of behavior Barclays engaged in, the FERC said bank traders would establish long financial swap positions, which settle against daily indexes each day of the month.
Against that the company would establish short positions in physical monthly indexes. Barclays would then cover its short index positions by buying dailies each day, a tactic that would artificially prop up the daily index settle.
While the company might lose in its short cash daily positions, it would profit more on its long financial swap positions for a net gain.
Levine stated in a note that Barclays would trade physical index to "protect a position" and requested her colleagues to "keep the PV (Palo Verde) index up and the SP daily index down" while she was on vacation.
Brin and Smith also discussed how Levine asked them to help her "prop up" indices and explained how doing so required the Barclays traders to take a "daily loss" trading the physical markets.
If Barclays had let the financial swaps settle without trading dailies against index to move the settlement, FERC alleged it would have realized a net loss.
BREAKING THE GOLDEN RULE
The FERC alleged the Barclays traders knew their loss-generating physical trading was likely unlawful and specifically ignored the warning of Joseph Gold, Barclays managing director and head of commodities for the Americas.
"Uneconomic trading activity was something which I tried to make sure was very clear to all the traders," Gold said he told traders, according to the FERC order.
"The golden rule was always, under no circumstances, lose money on a transaction for the intention of making money on another transaction."
Barclays hired Connelly as its Managing Director of North American Power in May 2006 to build and grow a North American power trading group for Barclays, reporting to Gold.
Connelly then hired former colleagues he had worked with at Mirant Corp: Ryan Smith, who had been at Mirant since 2000, and Karen Levine, who had been there since 2001, according to their work histories on LinkedIn. After Connelly joined Barclays, he hired Daniel Brin, a trader Connelly knew from Mirant, according to the FERC.
It was not clear what role, if any, the traders had at Mirant during the period of the California power crisis in 2000 to 2001. The merchant was later one of several companies to pay settlements of $500 million or more following federal and state investigations of manipulation in the power crisis.
All four left Barclays over the past five years for reasons unrelated to the investigation, and the bank effectively quit the Western power market this year.
Some of the traders are now consultants, according to their LinkedIn profiles. Smith got top marks from one of his subsequent colleagues at Xcel Energy, where he worked for three years after leaving Barclays in 2007.
"It doesn't sound like the Ryan that I had experience with," said Joe Morrato, an electricity executive who was a risk compliance manager at Xcel in Denver. "In my work with him at Xcel, he was nothing but ethical and compliant in every way."
Morrato could only recall writing up Smith for one violation in three years' time: executing a transaction based on what he thought was a direction from another executive, when in fact the executive denied giving him the direction.
It was indeterminate who was at fault, Morrato said, and he knew of no disciplinary action resulting from the write-up.