This week’s enforcement update covers:
- FERC issues 2018 Report on Enforcement showing continued focus on fraud and market manipulation;
- CFTC Enforcement Director discusses Enforcement trends and CFTC releases Annual Report on enforcement;
- CFTC orders Commerzbank AG to pay $12 million for swap dealing violations and misleading statements to the CFTC;
- Former commodities trading executive arrested for scheme to defraud employer by hiding trading losses; and
- CFTC and Kraft file oppositions to motions for summary judgment.
FERC issues 2018 Report on Enforcement showing continued focus on fraud and market manipulation. On November 15, FERC’s Office of Enforcement released its 2018 Report on Enforcement and related Staff presentation during FERC’s open meeting. The 2018 Report on Enforcement highlights FERC Enforcement staff’s continued focus on fraud and market manipulation, serious violations of mandatory Reliability Standards, anticompetitive conduct, and conduct that threatens the transparency of regulated markets.
As in previous years, the Report provides information regarding the nature of non-public enforcement activities, such as self-reported violations, surveillance inquiries and investigations that were closed without public enforcement action. Reviewing the investigations closed with no-action (including this year, a referral from a U.S. Attorney’s Office), as well as the separately discussed report on Division of Analytics and Surveillance (DAS) inquiries closed with no referral – provides good insight to the issues that trigger review and how FERC enforcement perceives market conduct. Review of the audit and accounting matters this year is also important considering the elevated attention tariffs are getting now.
Highlights of the 2018 Report on Enforcement include:
- Division of Investigations (DOI): In FY2018, DOI staff opened 24 new investigations, as compared with 27 investigations opened in FY2017. In addition to cases closed through settlement, staff closed 23 investigations in FY2018 without further action, as compared to 16 investigations closed without further action in FY2017. In addition, the Commission continues to litigate three cases in federal district court. DOI staff negotiated six settlements that resulted in more than $83 million in civil penalties and disgorgement of more than $66 million in unjust profits. These Commission-approved settlements included provisions requiring the subjects to enhance their compliance programs and periodically report back to Enforcement regarding the results of those enhancements.
- Division of Analytics and Surveillance (DAS): DAS staff reviewed numerous instances of potential misconduct and provided analytical expertise to Investigations staff in approximately 50 investigations. Natural gas surveillance screens produced approximately 7,719 alerts. Each month DAS staff ran and reviewed 84 electric surveillance screens, hourly and intra-hour sub-screens, and reports for more than 36,000 hubs and pricing nodes within six regional transmission owner and independent system operator regions.
- Division of Audits and Accounting (DAA): DAA staff completed 14 audits of oil pipelines, electric utilities and natural gas companies, resulting in 209 recommendations for corrective action and directing refunds and recoveries totaling more than $185 million. In addition, DAA advised and acted on 435 proceedings at FERC covering various accounting matters with cost-of-service rate implications.
- Division of Market Oversight (DMO): DMO staff continued its analysis of market fundamentals, and enhanced its capabilities for identifying anticompetitive market outcomes and anomalies that may indicate an exercise of market power. DMO published its 2017 State of the Markets Report and Seasonal Assessment reports. It also held two Electric Quarterly Report user group meetings to discuss potential system improvements and enhancements.
Since 2007, FERC Enforcement staff has negotiated settlements allowing for the recovery of approximately $776 million in civil penalties and approximately $511 million in disgorgements.
CFTC Enforcement Director discusses Enforcement trends and CFTC releases Annual Report on enforcement. On November 14, CFTC Enforcement Director James M. McDonald gave a speech on enforcement trends at the CFTC. According to Enforcement Director McDonald, the CFTC’s enforcement program over the last year largely centered around four priorities: (1) preserving market integrity; (2) protecting customers; (3) promoting individual accountability; and (4) enhancing coordination with other regulators and criminal authorities. Enforcement Director McDonald stated: “This was a year of incredibly vigorous enforcement at the CFTC. That’s true whether you measure it by the number of filed cases (third highest in CFTC history), amount of penalties imposed (fourth highest), number of large-scale matters (highest), types of cases charged (most ever involving manipulative conduct), number of parallel criminal actions (highest), percentage of cases that include individual charges (more than 2/3), or the number and amount of whistleblower awards (highest on both counts).”
In connection with this speech, the CFTC released the Division of Enforcement’s 2018 Annual Report, which details the CFTC’s work during FY2018. The Report details key metrics that reflect the work Division of Enforcement has done during FY2018, including statistics regarding the number of cases filed (83) and the relief obtained (more than $950 million in monetary sanctions). Of those 83 total actions filed, 26 involved manipulative conduct, false reporting or spoofing. The Report also explains a number of key initiatives that CFTC Enforcement began or continued during FY2018, including cooperation and self-reporting, data analytics, and the development of a set of specialized task forces focused on four different substantive areas — spoofing and manipulative trading, virtual currency, insider trading and protection of confidential information, and the Bank Secrecy Act.
CFTC orders Commerzbank AG to pay $12 million for swap dealing violations and misleading statements to the CFTC. On November 8, the CFTC issued an order filing and simultaneously settling charges against Commerzbank AG (Commerzbank) for numerous violations of the Commodity Exchange Act (CEA) and CFTC regulations, including failing to supervise its Swap Dealer’s activities for more than 5 years and making misleading statements and material omissions to the CFTC concerning its Swap Dealer’s operations and compliance with the CEA and CFTC Regulations. According to the order, Commerzbank management failed to supervise its Swap Dealer’s activities from December 31, 2012 until at least 2018. The CFTC’s order finds that Commerzbank’s failure to supervise its Swap Dealer was systemic and directly resulted in thousands of violations of other provisions of the CEA and CFTC regulations. The order requires Commerzbank to pay a $12 million civil monetary penalty and comply with specified undertakings, including retention of an outside consultant to review swap dealer compliance for a period of two years and to generate annual reports assessing the swap dealer’s compliance with the CEA and CFTC regulations.
Former commodities trading executive arrested for scheme to defraud employer by hiding trading losses. On November 7, the U.S. Attorney’s Office for the Southern District of New York announced the unsealing of a criminal complaint charging David Smothermon with wire fraud, in connection with a scheme to hide from his employer trading losses he incurred, by causing false entries to be made in the employer’s accounting system. According to the complaint, Smothermon worked for a privately owned firm, headquartered in Manhattan, engaged in the international marketing, distribution, and trading of commodities products, and Smothermon ran a Houston-based subsidiary specializing in the trading of liquefied petroleum gas. The complaint alleges that from December 2015 up to and September 2016, Smothermon caused false entries to be entered into an electronic accounting system used by the company in an effort to hide substantial trading losses generated by the subsidiary’s derivatives trading. U.S. Attorney Geoffrey Berman said: “As alleged, David Smothermon lied to his employer to conceal trading losses. He allegedly caused others to make false entries in his company’s accounting system to cover up the losses and reap substantial compensation. Smothermon’s actions allegedly caused his employer significant financial harm. Thanks to the FBI, David Smothermon has been apprehended and awaiting prosecution for his alleged self-dealing.”
CFTC and Kraft file oppositions to motions for summary judgment. On November 2, the CFTC and Defendants Kraft Foods Group, Inc. and Mondelēz Global LLC (Kraft) filed oppositions to each party’s motions for summary judgment in the U.S. District Court for the Northern District of Illinois. The CFTC argues that Kraft engaged in a scheme to stand for delivery on more than 3,000 futures contracts to send the market a false signal that it had demand for—and would load out and use—futures wheat. According to the CFTC, the overwhelming evidence in this case has shown that Kraft’s goal was to narrow the spread between the December 2011 and deferred-month wheat futures contracts, thereby causing the market to sell cash wheat to Kraft at lower prices, while earning Kraft a profit on its speculative “bullspread” futures position. The CFTC claims that Kraft had no intention of sourcing wheat from the futures market during the December 2011 SRW wheat futures contract expiration, as Kraft sourced no wheat in the futures market, made millions on its futures position as the spreads narrowed, and was able to buy cheaper wheat in the cash market.
Kraft states that the CFTC seeks summary judgment on two of its claims: (1) Count III, in which the CFTC alleges that Kraft violated CME’s position limits; and (2) Count IV, in which the CFTC claims that Kraft engaged in certain non-competitive wash sales. With respect to the position limits claim (Count III), Kraft argues that it fails because the CME provided Kraft a valid exemption from those limits. By attempting to acquire wheat through the futures market, Kraft argues that it protected itself against the risk associated with high cash market prices that Kraft would have faced if it had to later purchase the wheat needed for its bakeries through the cash market. In addition, Kraft claims that the non-competitive trading claim (Count IV) fails because Kraft did not determine how the transactions were executed and the transactions were not illegal wash sales.