Washington, D.C., April 22, 2014 – It’s a really gutsy move. Identical twins Rich and Kevin Gates, who run a small Pennsylvania hedge fund, are challenging the Federal Energy Regulatory Commission to sue them for allegedly violating the agency’s trading rules. Their firm – Powhatan Energy Fund – has been charged by FERC with engaging endeavors that “constituted manipulative trading in the PJM market.”
Bring it on, say the Gates twins, as laid out by Matt Levine in a Bloomberg commentary. Armed with the testimony of economics guru Bill Hogan, who largely invented the wholesale trading markets such as PJM that now dominate more than half of the U.S. electricity business, the Gates boys say FERC’s enforcement policies are irrational and incomprehensible. Also on their side is Rich Tabors, another of the seminal economics thinkers behind competitive energy markets.
They are also challenging the Obama administration’s nomination of FERC enforcement chief Norman Bay, whose expertise is as a federal prosecutor, to a slot on the commission and designation as chairman. Their charge, and that of others in the regulated community of traders, is that Bay has behaved as a bullying cop on the beat rather than a sophisticated overseer of complex and too-often opaque markets.
Last year, Hogan, at Harvard’s Kennedy School of Government, told Electricity Daily that FERC engages in “Orwellian double-speak” when it attempts to explain Bay’s approach to market manipulation. According to Hogan, the commission tends to close the cases with “a shroud of opaque settlements” entirely lacking in explanations of its legal and economic theory. “They don’t have explicit discussions of the cases, don’t have open analysis,” he said. “All we have [are] press releases and settlement agreements.” The standard that the FERC enforcement staff is now using in determining market manipulation, Hogan said, is akin to the comments of former Supreme Court Justice Potter Stewart about pornography: “I know it when I see it.” This casual approach, Hogan said, “strikes at the very core of the design of these markets.”
In his Bloomberg commentary, former investment banker and mergers and acquisitions lawyer Levine observes, “Two things you can say about the Federal Energy Regulatory Commission as a market regulator are:
* It produces the most incomprehensible prose of any market regulator, and
* Its markets have an unusual tendency to be gamed in embarrassing ways.”
The two are connected, argue Levine and the Powhatan twins. The opaque nature of the FERC interpretations of its rules, and its failure to discuss them in public, lead clever folks to find ways around them. Then FERC pounces, after the fact.
There is no doubt of the cleverness of the Gates boys. Indeed, Rich Gates is a prominent figure in the recent bestselling book by business writer Michael Lewis, “Flash Boys.” I just finished the book. It is a crushing exploration of how high-frequency securities trading rips off investors on both sides of trades in order to benefit middlemen who take no position in the trades and no risk. Gates figured out the basics of how the high-frequency traders were able to “front-run” markets and make easy money.
When Powhatan got the notice from FERC that it was allegedly manipulating the PJM market, as Levine recounts, the Gates twins responded: “Your preliminary findings make no sense. Should you choose to proceed with a public notice against Powhatan…pleased be advised that they will respond publicly and forcefully.” Good for them. And now they have
In addition to push-back by traders, the Bay nomination faces hurdles involving Senate Democratic politics. According to my reporting, former FERC Chairman Jon Wellinghoff advanced the Bay nomination with Senate Majority Leader Harry Reid of Nevada, after Wellinghoff’s first choice, former Colorado regulator Ron Binz, crashed and burned in the Senate. Reid earlier arranged for former Nevada consumer advocate Wellinghoff to become a FERC member and later chairman.
Wellinghoff, I’m told, is not a fan of acting chairman Cheryl LaFleur, whose appointment to the commission is up in June. The two frequently clashed in private. But new Senate Energy and Natural Resources Committee head Mary Landrieu (D-La.), not a fan of Wellinghoff or Reid or the Obama administration’s energy policies, has made it clear she won’t schedule a confirmation hearing for Bay until the White House gives LaFleur another five-year appointment to the commission. So far, it’s a standoff.