US regulators turn light on rule-making and enforcement

As energy companies work to comply with a range of new industry rules, how can risk managers ensure a robust compliance regime that is in step with the changing regulatory environment? Pauline McCallion finds out

Enforcement proceedings filed by the Commodity Futures Trading Commission (CFTC) have increased by 42% between 2008 and 2010. There were 57 actions over allegations of manipulation, fraud, abuse and other violations of the Commodity Exchange Act in the 2010 fiscal year <>, with more than $186 million in penalties, restitution and disgorgement collected by the regulator. A total of 419 investigations were opened <>> this year by the CFTC, that is 66% more than last year.
   
But while enforcement actions may have increased, regulators have also been reaching out to the industries they oversee in a bid to communicate new rules and attitudes to regulation. Whether it’s part of a long-term plan to boost industry compliance, as with the Federal Energy Regulatory Commission (FERC), or the result of increased responsibilities, in the case of the Commodity Futures Trading Commission (CFTC), regulated companies currently have a significant opportunity to have their say about how energy markets should evolve.

Playing a greater role in rulemaking and implementation will not just benefit the wider industry, but could also give energy companies the inside track when designing their own compliance regimes. Keeping track of proposed rules and submitting comments under the Dodd-Frank Act, for example, will give energy traders a clearer picture of how the regulator hopes to structure the market for derivatives trading and how to design a robust compliance strategy that is in tune with that new structure.

Boosting transparency
The CFTC embarked on a year-long rulemaking process after the enactment of the Dodd-Frank Act on July 21, 2010. The legislation has kick-started a comprehensive overhaul of the regulator’s duties and responsibilities, which will increase its size and scope. In line with this, the CFTC’s website provides access to the legislation itself, as well as proposed rulemakings and information on how to file comments. In addition, the regulator has also been publishing details of all external meetings conducted by CFTC Chairman Gary Gensler and his staff about the implementation of the legislation.

The ongoing implementation of the Dodd-Frank Act has aroused the interest of many energy companies and industry organisations that have not traditionally had contact with the CFTC. David Castelveter, vice president of communications at the Air Transport Association – a US trade body representing airlines, many of whom use derivatives to hedge fuel price risk – says Chairman Gensler “has been aggressive in encouraging industry comment”. As a result, he says organisations such as his have seen transparency in the current rulemaking process.

The staff of the Electric Power Supply Association (EPSA) has been similarly impressed by the CFTC’s recent efforts to engage the industry. Dan Dolan, vice president of policy research and communications at EPSA, says: “Our experience of FERC is that it does a good job in making things like proposed rules available for public comment and encouraging the stakeholder community to get engaged, both through commenting and through technical conferences and workshops. We’ve been pleased to see that, at least in terms of the implementation of the Dodd-Frank Act, the CFTC has taken a similar approach by holding open meetings in which they have really encouraged the industry to participate and in asking for public comment before making any final decisions on new rules.”

While FERC is not directly involved in the Dodd-Frank Act rulemaking process, it has also been working to enhance its enforcement programme, ensuring the energy companies it regulates have the opportunity to participate by filing comments and recommendations. FERC spokesperson, Mary O’Driscoll, says the Commission has a well-established administrative procedure for issuing rulemakings that involves notices of proposals and time periods for public comment before any final action is taken by the Commission. The aim of this is to ensure energy companies have time to comment and can view any relevant information on FERC’s website.

Since at least the enactment of the 2005 Energy Policy Act, FERC has also stressed the importance of developing rigorous compliance programmes to reduce the likelihood of violations. The regulator’s most recent action on enforcement was to issue a penalty guidelines policy statement on September 16, 2010. The new guidelines will apply to penalties issued by FERC for violations of its requirements and were created in an effort to enhance its enforcement programme to ensure fairness, consistency and transparency in all penalty decisions, according to the Commission.

While the new guidelines are unlikely to spur any radical changes to energy company compliance strategies, it provides a clearer idea of what is expected by the regulator, according to Susan Court, the first director of enforcement at FERC and now a partner in law firm Hogan Lovells' energy practice. The new guidelines are a “major milestone” in FERC’s enforcement programme, Court says, assigning specific weightings or credits to factors such as the seriousness of the violation and efforts to remedy the situation. “The order gives energy companies a bit more detail compared to earlier statements, about what a robust compliance programme should look like and about the important components of an effective compliance programme,” she adds.

One key aspect is timely self-reporting. According to Court, the September publication could prompt a change in how energy companies deal with FERC, in this respect. “FERC said that if a company identifies and self-reports a violation with no unreasonable delay and has an effective compliance programme in place, it would get credit for that,” she explains. “Conversely, if a company unreasonably delays self-reporting a violation, even if it has an effective compliance programme, it won’t get any credit for that.” The guidelines provide a three-point credit for having an effective compliance programme.

Court believes that the latest FERC communications tie in with the overall regulatory environment at the moment, including efforts by the CFTC and FERC to make their actions more transparent. “The CFTC and the rulemakings it has to promulgate over the next year for the Dodd-Frank Act exemplifies this,” she says, “It really is engaging in a very transparent process for rulemaking.”
 
Moving from rulemaking to enforcement, Court stresses the delicate balance that regulators have to maintain between conducting meaningful investigations and protecting the privacy of those people or companies that are being investigated. “Investigations are inherently non-public proceedings, so to try to make those proceedings more transparent is a challenge. I think what the commission is trying to do here is at least shine some light on what is normally a non-public, non-transparent process.”

Robust compliance
Just as regulators have been making themselves more transparent and approachable, so must energy companies when it comes to compliance. Obiamaka Madubuko, a partner at law firm McDermott Will & Emery, says encouraging staff to speak up internally will allow companies to investigate any potential problems and, in the case of a violation, approach the regulator with all of the relevant information to ensure a speedy external investigation and, possibly, a lighter punishment if a violation is uncovered. Speaking during a September webcast for companies likely to be affected by the CFTC’s new derivatives trading regime, Madubuko’s colleague, Fredric Firestone, said: “You won’t get credit for rushing in with a poor presentation and incorrect information. Gather the facts and have a strategy laid out to deal with the situation [before approaching the regulator]. Companies should keep in mind that the regulator will look at what the company did and how it reacted throughout any investigation.”

During the same presentation, Madubuko pointed out that companies can “minimize their exposure by maximizing their compliance”. Discussing a new whistleblower programme enshrined in the Dodd-Frank Act that encourages employees to step forward to the regulator about violations at their own companies, Madubuko urged companies to re-evaluate their compliance programmes to ensure it remains a top company priority. This can be done via a strong code of ethics set from the top down, as well as adequate funding and staffing for compliance staff, training for all staff and strong anti-retaliation policies to encourage staff members to flag up any issues or potential violations internally. This helps management to approach the regulator having already conducted a timely investigation and with a suggested remediation plan.

Encouraging employees to buy into maintaining a robust compliance regime should help companies refine their strategies when it comes to detecting and investigating potential violations. Technology can also play a role in monitoring operations and flagging up potential violations of any new or existing rules. “The enforcement regime within the energy sector has cranked up recently, in the US in particular as a result of the Dodd-Frank Act,” says S. Ramakrishnan, head of technology company Oracle’s Reveleus and Mantas risk management products. “Overall we have seen a significant interest in enforcement from financial institutions that participate in energy and commodity trading, as well as the energy providers themselves and the intermediaries involved in the system. Strictures and fines [from regulators such as the CFTC and FERC] have focused the minds of these entities because of the vulnerability they are concerned they might have.”

Oracle has developed an energy and commodity-focused trade surveillance product in response to demands from energy and commodity customers. The system automates trade surveillance, identifying any unusual behaviour on trading desks or potentially problematic practices. The system can also act as a source of information during any internal or external investigations, according to Ramakrishnan.

In rolling out the product, Ramakrishnan has noticed that energy companies often don’t have very sophisticated processes in this area. “Typically, we are not replacing any kind of sophisticated detection technology, we are just replacing reporting systems,” he says. “We think the regulators saw traditional methods of reporting as inadequate and want to ensure there is much greater audit accountability control and true knowledge of what has transpired during a trade.”

Keeping current
While bigger players may have more developed policies, it is important for all companies to ensure they are able to keep track of their activities, particularly as regulators begin to tighten their grip on the markets. Speaking at an International Energy Credit Association in Tucson, Arizona in October Michelle Foss, chief energy economist and head of the Centre for Energy Economics at the University of Texas, urged end users to “get organised” when it comes to keeping track of the rulemaking process surrounding the Dodd-Frank Act. She said that companies could ensure compliance by paying attention to regulators and engaging with them during the current proposal process for new rules under the legislation.

This is the current strategy of electricity firm Entegra Power Group, according to Vincent Crane, the company’s chief risk officer. “I’m sure we will be making changes to our compliance regime in future [in light of new derivative trading regulations], but what we have done thus far is follow developments at the CFTC. We have already begun to draw up a strategy document so that we can start implementing the specifics, but at this point it’s little more than a skeleton.”

At present, Crane’s energy trading compliance strategy is based on a 120-page risk policy document, which is reviewed on a quarterly basis. In terms of external requirements, the company also has policies in place to comply with Sarbanes-Oxley Act requirements.

Crane keeps an eye on developments at the CFTC by listening to live webinars and conference calls on rulemakings conducted by the regulator, as well as following developments on its website and keeping an eye on news reports related to the rulemaking process. “But at this point, and with a company our size [approximately 150 employees in total], we have not had any direct interaction with the CFTC, nor am I involved right now in any of our trade organisations’ efforts,” he says.

According to the CFTC’s website, by mid-October it had conducted more than 250 external meetings and public appearances related to the Dodd-Frank Act rulemaking process since July 26, 2010, with companies ranging from banks and exchanges to large energy market players such as Shell Energy North America and trade groups such as the American Public Gas Association (APGA) and the Edison Electric Institute (EEI). The issues discussed included position limits, defining market participants and their duties under the new regime, and the end-user exemption from certain requirements of the Act.

Commenting on the decision to publish details of all outside meetings during the rulemaking process in September, Chairman Gensler said: “The CFTC is committed to promoting both market and agency transparency . . . This commitment to open government will help promote the integrity of the rule-writing process.”

EPSA’s Dolan sees the online publication of the list of meetings as an interesting move from the CFTC. “I think the CFTC did this because it has been bombarded by so many organisations like ours, that have not historically been involved with the CFTC but that are now. It lets the public know who the regulator is working with and what issues are being discussed.”

Whether this will increase public confidence in the rulemaking process and in the regulator, remains to be seen but stakeholders seem to see it as a positive step by the CFTC. “I think it allows the public to be more confident that these decisions are not being made behind closed doors, that all of this is out in the public domain,” adds Dolan. “It has been a positive move in giving a better sense of the level of transparency that the agency hopes to maintain.”