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Second Circuit Upholds CFTC Enforcement Action for Manipulative Trading of Electricity Contracts

Energy Law Update

November 17, 2009

The United States Court of Appeals for the Second Circuit recently upheld a civil enforcement action by the U.S. Commodity Futures Trading Commission ("CFTC"), which found that a New York Mercantile Exchange broker "knowingly" manipulated settlement prices for electricity future contracts on behalf of Avista Energy, Inc. in 1998. Although the Court ultimately lowered the CFTC's penalty by one-third, the Court affirmed the CFTC's cease-and-desist order, registration revocation, and 20-year trading prohibition. The allegedly manipulative trading practices presented an issue of first impression for the CFTC under the Commodity Exchange Act.

The CFTC originally initiated the enforcement action in 2001 against defendants DiPlacido and two former Avista Energy employees, alleging that on several days in 1998 the three engaged in a strategy to "slam the close", which entails efforts to "materially raise or lower the settlement price of NYMEX Western U.S. electricity futures contracts . . . with a large buy or sell order to profit via an artificially created increase in the value of its [OTC] derivatives contracts." The CFTC settled with the Avista employees for $2.1 million and imposed a $1 million fine as well as other penalties on DiPlacido. 

The DiPlacido opinion is noteworthy in two respects. First, DiPlacido is the first CFTC action to find manipulation based solely on trade practices such as "slamming the close", as compared to prosecutions of "corners" or "squeezes", which generally involve manipulation of futures prices through control of the cash market. Second, and perhaps more interesting, the DiPlacido decision stands in contrast to a recent opinion from the Eastern District of Texas, U.S. v. Radley, which rejected the CFTC's definition of "price artificiality" as impermissibly vague. Although Radley involved criminal charges and a different procedural history, both the Radley and DiPlacido cases largely turned on the concept of "price artificiality" as it relates to the CFTC's analysis of market manipulation. In Radley, the defendant argued that the CFTC's test lacked "support in the law and in the marketplace" because, under the government's construction, "any activity in a market by parties other than producers or consumers would not be a legitimate force of supply and demand." The Court agreed and held that under the CFTC's construction of "price artificiality", "any activity in a market by parties other than producers or consumers would not be a legitimate force of supply and demand".

On DiPlacido's appeal, the Second Circuit held that the CFTC had acted "reasonably [in its administrative adjudication] in concluding that DiPlacido had the ability to influence prices where, on the relevant dates, his trades over two minutes at the Close accounted for an average 14% of a full day's volume." The Court further upheld the CFTC's findings that DiPlacido's trades established "artificial prices" by virtue of the fact that he "violated bids and offers" for the purpose of raising prices (a practice of involving offering at lower than prevailing bids or bidding at higher than prevailing offers in the ring). Thus, even though the Court acknowledged that it is difficult to distinguish between artificial prices and those that result from natural forces of supply and demand, the Court upheld the CFTC's findings, primarily couched in deference to the CFTC. 

As the CFTC continues to exercise its oversight in areas traditionally within its jurisdiction and its jurisdiction in new areas is proposed to grow, such as over-the-counter swap markets and carbon markets, the implications of CFTC manipulation cases increase significantly. In contemplating the analysis of such claims, the differences between DiPlacido and Radley on the concept of price artificiality as it relates to market manipulation underscore the intricacy of these types of cases, which often involve complex fact patterns and similarly complex legal and economic theories.