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Amaranth Fine May Signal More U.S. Futures Regulation

Date: Friday, October 26, 2007
Author: Tina Seeley and Matthew Leising, Bloomberg.com

Goldman Sachs Group Inc., Morgan Stanley and U.S. futures exchanges are fighting efforts by Congress to give two regulators authority over the $4.2 trillion commodities market, a move they say will drive trading overseas.

At issue is whether the Federal Energy Regulatory Commission, armed with new powers, can levy fines against failed hedge fund Amaranth Advisors LLC for manipulating natural-gas futures prices. Goldman and Morgan Stanley, working through their trade group, say Amaranth should only face discipline from its current regulator, the Commodity Futures Trading Commission.

The energy agency, meanwhile, is being urged on by California Senator Dianne Feinstein and House energy committee Chairman John Dingell. If FERC succeeds with Amaranth, opening the door for the agency to pursue other market-manipulation cases, banks might quit U.S. exchanges for overseas markets, says Craig Pirrong, a professor at the University of Houston.

``This could be a classic example of the law of unintended consequences,'' says Pirrong, director of the university's Global Energy Management Institute. ``It would be likely that these folks would remove themselves from these markets'' rather than be subject to two overseers, he said.

FERC has a lower standard for charging market manipulation than does the CFTC, Pirrong says: While the commodities agency rarely alleges manipulation because it must prove intent, the energy regulator can bring a case if a bank or hedge fund's trading is shown to move prices, with or without intent to manipulate.

$6.6 Billion Loss

Amaranth, whose wrong-way bets in natural-gas trading led to its collapse with $6.6 billion in losses last year, is challenging the legality of FERC's proposed $291 million fine against the company and its advisers in federal courts in New York and Washington. That fine is almost as much as the entire amount of penalties the CFTC collected from energy companies and market participants from December 2002 to the end of September.

The CFTC announced today that BP Plc, Europe's second- largest oil company, will pay a record $303 million to settle claims that it manipulated the U.S. propane market three years ago. The settlement ``sends a clear message to others that manipulating a commodities market has serious consequences,'' CFTC Acting Chairman Walter Lukken told reporters in Washington.

Coalition of Support

Amaranth, based in Greenwich, Connecticut, is backed in its case against FERC by the Wall Street firms, the CFTC and a coalition consisting of most of the nation's futures exchanges.

Feinstein, a Democrat, has sought to expand FERC's power ever since the agency was slow to rein in manipulative trading by Enron Corp. in California in 2000-2001. She was an author of 2005 energy legislation that gave FERC new authority.

The two agencies should ``speak with one voice'' on market- manipulation standards, says Jeff Sprecher, chief executive officer of Intercontinental Exchange Inc., owner of Europe's largest energy market. ``The fear is one agency tells you to zig and one tells you to zag,'' says Sprecher, whose exchange is overseen by both FERC and CFTC because it deals with physical power contracts and energy futures trading.

FERC, set up in 1977, regulates wholesale power sales and the interstate transmission of electricity, natural gas and oil. It deals mostly with the trading of physical products on spot markets, rather than with futures contracts tied to exchange- traded commodities. The CFTC was formed in 1974 to police commodity futures and options, most of which were related to agricultural products. The panel's oversight now extends to futures contracts based on products ranging from pork bellies and crude oil to interest rates.

`Need Both'

The Amaranth case marks the first time FERC has tried to use its power to punish alleged wrongdoing in futures markets, though the agency denies it intends to regulate the markets.

``The American people need both FERC and CFTC to fight market manipulators, not each other,'' Feinstein and Democratic Senators Maria Cantwell of Washington and Ron Wyden of Oregon wrote in a Sept. 20 letter to the heads of the two agencies.

Energy-panel chairman Dingell, a Michigan Democrat, and Representative Joe Barton of Texas, the committee's senior Republican, said in a separate letter: ``We expect FERC to engage in active oversight and to make appropriate and vigorous use of these new authorities.''

Trading in the futures market has risen 442 percent in the last seven years, the CFTC's Lukken told a congressional panel yesterday. That growth has brought a record increase in cases of market-rigging, the commission says.

Feeling Pressure

The commission this year charged Energy Transfer Partners LP with trying to depress natural-gas prices after Hurricane Rita. Marathon Oil Corp. in August agreed to pay $1 million to settle charges it tried to manipulate oil prices.

The CFTC may be feeling pressure to show it's ready to step up its pursuit of market manipulators even more.

Lukken asked Congress yesterday to allow the agency to impose fines similar to those levied by FERC, $1 million per violation per day. The CFTC wants the penalties ``to reflect the economic severity of such activity,'' he said in testimony to a House subcommittee.

Investment banks and hedge funds have an increasing stake in the futures market. So-called non-commercial traders accounted for 52 percent of the natural-gas market on the New York Mercantile Exchange in July, up from 42 percent three years earlier, says Jeffrey Harris, chief economist for the CFTC.

No `Dual Regulation'

John Damgard, president of the Futures Industry Association, says subjecting banks and other investors to two sets of regulation in futures markets would be too confusing and would push trading out of the U.S.

``Nobody is going to subject themselves to dual regulation if they don't have to,'' says Damgard, whose group represents New York-based Goldman, Morgan Stanley, Merrill Lynch & Co., JPMorgan Chase & Co. and other banks. ``For FERC to be out there enforcing the Commodity Exchange Act is ridiculous.''

Pirrong says if FERC is allowed to regulate futures markets, trading in crude oil may shift to exchanges in Europe or the Middle East. Other trading may migrate to the private, over-the-counter market that is beyond U.S. regulation, he says.

Robert Webb, a finance professor at the University of Virginia and former trader at the Chicago Mercantile Exchange, agreed, saying, ``There is a cost in terms of misguided regulation.''

The Singapore International Monetary Exchange took trading from Japanese stock markets in Tokyo and Osaka during the 1990s because its regulations were less burdensome, Webb said.


The Sarbanes-Oxley Act, the 2002 U.S. law that tightened corporate-governance standards after Enron's collapse, has also been blamed for driving companies away from the U.S.

Some of Europe's largest companies have removed their shares from the New York Stock Exchange rather than face the added expense imposed by regulations such as Sarbanes-Oxley. Bayer AG, Germany's largest drugmaker, said last month that it will no longer trade in New York. Listings of non-U.S. companies on the Big Board dropped to 421 as of Oct. 19, down 11 percent from 2002, according to the exchange's Web site.

Michael Duvally, a spokesman for Goldman, declined to comment on the prospect of having a new regulator. So did Jennifer Sala, a spokeswoman for Morgan Stanley.

The CFTC says it has sole authority to oversee futures markets.

`Regulatory Gap'

BP's settlement with the CFTC today shows ``there are no regulatory gaps when it comes to our pursuit of manipulation in America's commodity markets,'' says Gregory Mocek, director of enforcement for the commission.

A coalition including the Futures Industry Association, New York Mercantile Exchange and Managed Funds Association filed a brief this month supporting the CFTC in the Amaranth case.

FERC Chairman Joseph Kelliher says the banks want to avoid the prospect of paying heavier fines.

``I don't think it's a surprise that participants subject to penalties would prefer smaller penalties to larger penalties,'' says Kelliher, who argues that the agency isn't seeking to regulate futures markets.

Should Amaranth's argument prevail, he says, it will create ``a regulatory gap, and I think it might encourage attempts to manipulate.''

To contact the reporters on this story: Tina Seeley in Washington at tseeley@bloomberg.net ; Matthew Leising in New York at mleising@bloomberg.net