Over the past several years, the Federal Energy Regulatory Commission (FERC), the Federal Trade Commission (FTC), and the Commodity Futures Trading Commission (CFTC) have all been given statutory authority—authority patterned after that given to the Securities Exchange Commission (SEC) in § 10(b) of the Securities Exchange Act—to punish market manipulation. Although all four agencies now have nearly identical regulations on their books prohibiting market manipulation, there does not appear to be much consistency among the agencies on just what they think market manipulation really is.
A recent discussion paper by The Brattle Group titled “Losing Money to Increase Profits: A Proposed Framework for Defining Market Manipulation” goes a long way towards articulating a practical definition of market manipulation. The question is not merely theoretical. Regulators need to know what to look for and how to build a solid enough case to reliably prosecute instances of market manipulation. In addition, the regulated community needs to know what market manipulation is in order to build effective compliance programs to prevent its occurrence.
The Brattle Group’s definition makes a lot of sense. It asserts that market manipulation occurs when an entity intentionally loses money on a price-setting transaction to benefit related positions in price-taking transactions. Selling physical natural gas at a loss to help drive down an index price in order to make a profit on transactions that are priced at the index should be considered manipulation. The Brattle Group’s discussion paper explains how the definition could be applied and used, as well as a variety of situations to address the circumstances commonly understood to be market manipulation. I think it would be beneficial for all of the agencies (FERC, CFTC, FTC, and SEC) to consider adopting a common definition for market manipulation and to look closely at The Brattle Group’s proposal.
The definition, however, raises one interesting issue—what happens when the price-setting transaction is regulated by one agency and the price-taking transaction is regulated by another agency? Which agency has jurisdiction to prosecute the manipulation? The FERC and the CFTC have been at odds over jurisdiction ever since FERC instituted proceedings against Amaranth Advisors for allegedly manipulating exchange-traded natural gas futures (regulated by the CFTC) because the futures index sets the price of physical natural gas sales (regulated by FERC).
In order for The Brattle Group’s proposed definition of market manipulation to succeed, the agencies would have to agree on how to proceed when more than one regulator is involved. When an entity intentionally loses money selling physical natural gas at Henry Hub in order to drive down the Henry Hub index price because it would benefit the entity’s futures position at Henry Hub, which agency would prosecute the manipulation scheme—FERC, CFTC, both?
I suggest that the agency that regulates the price-setting transaction would have primary jurisdiction to prosecute the manipulation, with the agency that regulates the price-taking transaction assuming a supporting role. The agency that regulates the price-setting transaction would have a better understanding of when a loss would be explained by legitimate business purposes or when that loss is the trigger for a manipulation scheme. In the example above, FERC would have primary jurisdiction to prosecute an alleged manipulation based on losses on physical natural gas sales in order to benefit a position in the futures market. If the situation were reversed (the losses were in the futures market to benefit physical sales positions), the CFTC would have primary jurisdiction. However you may come out on this question, one agency only should take the lead so that all parties—regulators and regulated alike—know the rules of the road.