FY 2009 Performance Budget Request

Enforcement: Introduction
_____________________________________________________________________________________________________________________

CHAPTER 3: ENFORCEMENT
Prevent Market Manipulation

Total Resources for Enforcement Program

(Dollars in Thousands)

FY 2007 FY 2008 FY 2009

Actual Estimate Request
Funding 11,177 31,568 34,645
Program 6,614 26,279 29,017
Support 4,563 5,289 5,628
FTEs 153 174 189
Program 124 143 156
Support 29 31 33

Introduction
Competitive energy markets can succeed only when competition is
combined with effective regulation. The Commission has adjusted its
regulatory policies to meet the dramatic changes that have occurred in
both the natural gas and electricity industries. While the core legal duties
of the Commission have not changed, to guard against unjust and
unreasonable rates and undue discrimination and preference, the means of
discharging this duty have evolved over time. The Commission ordered
the unbundling of natural gas sales and transportation in a series of
landmark orders, which proved to be an unqualified success. In the wake
of these orders, the Commission witnessed a surge of activity by interstate
natural gas pipelines, as they sought to restructure the way they did
business and interconnected to new markets. As a result, market areas are
now served by more pipelines and there is more competition for shippers’
business, who themselves have seen their number of choices increase.
Overall, the cost of gas transportation has fallen while throughput has
risen.

With respect to wholesale power sales, the Commission used to prevent

the exercise of market power by setting rates for each individual seller
under cost-based regulation. Today, the Commission permits market-
based rates for most sellers and increasingly sets rules of general
applicability that govern an entire market. As a result of this regulatory

- 78 -
 FY 2009 Performance Budget Request
Enforcement: Introduction
_____________________________________________________________________________________________________________________

approach change, it is even more important for the Commission to enforce

compliance with its regulations and orders, and to monitor market power
to ensure that market-based rates remain just and reasonable.

The Commission seeks to detect violations quickly, publicize misconduct

where appropriate, and take prompt action to prevent future misconduct.
The Commission can identify violations by many methods, including
review of market information required to be filed by market participants;
investigation of significant price spikes or market anomalies; periodic
audits of compliance with Commission tariffs, rules and regulations;
referrals from RTO and ISO market monitors; tips and complaints from
the public and market participants; and self-reports of violations by
companies. (The Commission’s Enforcement Policy Statement issued in
October 2005 encourages companies to self-report violations to mitigate
remedies). It is important that the Commission understands market
“The Energy Policy Act dynamics, detects problems or issues in energy markets early, prevents
of 2005 permanently violations of its rules, and enforces compliance with the laws under its
changed the
jurisdiction. Perhaps most important, the Commission needs to ensure that
Commission. It outlawed
market manipulation in utilities subject to its jurisdiction have effective internal monitoring and
power and gas markets, compliance programs in place to help assure that they are following
gave us responsibility to established Commission rules and regulations. Commission oversight
assure reliability of the must then provide an independent and external check to ensure that the
electric grid, and gave us
compliance programs of jurisdictional utilities are adequate. Further, the
meaningful enforcement
tools that we badly Commission periodically audits utilities’ compliance with the
needed. Congress Commission’s rules, regulations, and statutory requirements.
entrusted the
Commission with The Commission’s two main objectives in meeting its goal of preventing
substantial civil penalty
market manipulation are:
authority, and we are
using that penalty
authority firmly and ! provide vigilant oversight; and
fairly to sanction ! provide firm but fair enforcement.
wrongdoing and to
encourage compliance.
Each year the Commission performs investigations and conducts audits for
We are now an
enforcement agency noncompliance with the laws and regulations under its jurisdiction. While
capable of very effective these actions help to deter violations from occurring in the first place, the
oversight, and are Commission takes even greater steps on a variety of fronts to reduce the
dedicated to becoming a probability that violations will occur, and detect problems before they
preeminent enforcement
become severe or widespread. To prevent market participants and
agency.”
regulated entities from unknowingly violating the Commission’s rules, the
Joseph T. Kelliher Commission works with stakeholders to explain the intent and
FERC Chairman requirements of its rules and the laws it administers.

The Commission’s enforcement tools were greatly reinforced when EPAct

2005 conferred expanded authority, which provided, for the first time,
penalty authority for violations of the NGA and all of Part II of the FPA.
It further provided or increased (for violations of the NGPA) the level of
penalties to $1 million each day for the duration of the violation. Penalties

- 79 -
 FY 2009 Performance Budget Request
Enforcement: Introduction
_____________________________________________________________________________________________________________________

of this magnitude also are applicable, pursuant to EPAct 2005

amendments to the FPA and NGA, to any entity (not just traditionally
jurisdictional companies) who manipulates wholesale natural gas or
electric markets by engaging in fraud or deceit in connection with
jurisdictional transactions. Armed with this expanded authority, the
Commission will create an even stronger and more effective compliance
and enforcement program to protect the public interest.

To perform its additional responsibilities resulting from EPAct 2005, the

Office of Enforcement will require additional resources in FY 2009 of 13
FTEs. Among many other tasks, the Commission must periodically audit
the ERO for ongoing compliance with the statutory and regulatory criteria
for both certification and the ERO’s performance in enforcing reliability
standards. The ERO will audit each Regional Entity to ensure it is
adequately carrying out its responsibilities. However, the Commission
retains the authority, and indeed has the responsibility to participate in any
ERO compliance audit of a Regional Entity or conduct its own compliance
audit. The Commission will also have a role in auditing the ERO and the
Regional Entities’ budgets, filed annually with the Commission. The ERO
will likely audit one-third of the Regional Entities each year with limited
to medium involvement required by the Office of Enforcement.

In addition to these duties, the Commission will investigate incidents and

allegations of non-compliance with the reliability standards. If violations
are uncovered in any of these inquiries, the Commission will lead
reliability-centered investigations and develop legally-sufficient cases for
possible litigation. The Commission’s new reliability staff will be
necessary for these investigations because of their technical expertise,
familiarity with reliability standards, and experience in the industry. The
reliability staff will play a substantial role in these investigations as
technical advisors, possible expert witnesses, and investigators.

Approximately 12 reliability-related, Commission-initiated, and/or

complaint-driven audits are expected per year. An appropriate number of
reliability incident-driven investigations (such as the rolling blackouts in
California, Colorado, and Texas in the last 24 month period) and other
investigations into possible violations of reliability standards are also
expected.

The Commission is currently developing the rules which ultimately will

form the basis for these auditing and investigative activities. However, the
Commission currently does not have auditors or investigators solely
performing these new functions. The additional resources requested will
allow staff to work specifically on these new responsibilities without
compromising other Commission efforts.

- 80 -
 FY 2009 Performance Budget Request
Enforcement: Introduction
_____________________________________________________________________________________________________________________

Allocation of Enforcement Resources

Objective A: Provide Vigilant Oversight
(Dollars in Thousands)

FY 2007 FY 2008 FY 2009

Actual Estimate Request
Funding 3,612 9,283 9,340
Program 2,146 7,726 7,821
Support 1,466 1,557 1,519
FTEs 49 51 51
Program 40 42 42
Support 9 9 9

Objective A: Provide Vigilant Oversight

Energy markets are complex and change rapidly. When problems develop
in energy markets without a remedy, they can seriously affect millions of
customers. Therefore, a key part of the Commission’s market-oriented
approach to the natural gas and electric power industries is to identify
potential problems quickly and to address them before they become
severe.

Objective A Identify and Remedy Problems with Structure and Operations in

Strategy 1 Energy Markets

To accomplish this objective, the Commission has developed a

comprehensive program of energy market oversight. To support the
energy market oversight program, the Commission acquires and processes
large amounts of energy market information. Energy market oversight
and information are an integral part of the overall Office of Enforcement.
Issues that market oversight identifies quickly feed into investigations and
audits, as appropriate.

Identifying Problems through Energy Market Oversight. Market

oversight is the core of the Commission’s efforts to identify problems in
energy markets. The energy market oversight program reviews all key
markets daily to detect both suspicious behavior by individual market
participants and problems with market rules or operations that
significantly affect outcomes. Understanding the scope of this program
requires knowing which markets the Commission monitors and how it
goes about tracking them.

- 81 -
 FY 2009 Performance Budget Request
Enforcement: Provide Vigilant Oversight
_____________________________________________________________________________________________________________________

Markets Monitored by the Commission. The market oversight program

focuses most closely on the Commission’s most direct concerns,
wholesale physical markets for natural gas and electric power and
associated transmission markets. For natural gas, the Commission’s
oversight includes examining detailed prices, price differences among
different points on the grid, use of the interstate natural gas pipeline grid,
supply of natural gas (both production and imports, including LNG),
demand levels, storage activity, and, where possible, trading patterns. By
observing all these aspects of the natural gas industry, the Commission can
detect longer-term problems (for example, potentially tight markets a
season ahead) and short-term market anomalies (for example, unusual
trading patterns or price differences that are not consistent with pipeline
usage).

For electric power, market oversight includes examining detailed prices,

price differences geographically and over time, use of the transmission
network, generation levels, overall demand levels, and, where possible,
trading patterns. In RTO and ISO markets, the Commission works closely
with market monitoring units to ensure comprehensive coverage of all
activity in those markets. Staff in the Market Monitor Relations Branch
focus on working with the Market Monitors in the Commission-approved
RTOs and ISOs as well as those approved by the Commission outside of
the organized markets (e.g. in the context of a major merger between
electric utilities). Market oversight for electric power allows the
Commission to detect longer-term problems (for example, infrastructure
deficiencies) and short-term market anomalies (for example, unexplained
price or trading patterns).

The oversight program also closely examines connections between natural

gas and electric markets. In many cases, natural gas is the marginal fuel
for electric power; often the price of electric power closely tracks the gas
price. Electric generation also is frequently the marginal use for natural
gas, so that electric usage can strongly affect natural gas prices. The
Commission’s market oversight program examines detailed interactions
between the two industries to detect any possible problems as soon as
possible.

Finally, many other markets affect the operation of the physical electric
power and natural gas markets. As a result, the Commission’s market
oversight program reviews related markets every day, including:

! Financial markets for electric power and natural gas. These markets
give market players many ways to manage the large risks involved in
all energy markets. But problems can and do develop in the interface
between physical and financial markets.

- 82 -
 FY 2009 Performance Budget Request
Enforcement: Provide Vigilant Oversight
_____________________________________________________________________________________________________________________

! Generation inputs. These include fuel (coal and oil as well as natural
gas) and emissions credits. One can only assess the meaning of prices
in power markets in relation to prices in related input markets.

! Long-term financial markets. A crucial question for both natural gas

and electric power is the ability of the industries to invest in new
infrastructure when needed. The market oversight program tracks
long-term investments in the industries, along with related financial
markets.

! International markets. The United States and Canada form a tightly

integrated continental energy market. Market oversight tracks
developments in Canada that may affect the United States. It also
tracks the growing natural gas market in the Atlantic Basin between
Europe and North America.

How the Commission Monitors Markets. The Commission’s market

oversight program employs a series of staff experts on various natural gas
and electric power markets. The centerpiece of the program is a daily
meeting in which oversight staff review developments in all relevant
markets for the previous day. The meeting follows a standard format to
ensure that all key markets are covered, but analysts are encouraged to
bring up any additional issues they have observed. Since the various
markets are highly interconnected, the daily staff meeting allows all the
analysts to see how developments in one market are affecting the others.

Each daily meeting identifies any market anomalies that require further
explanation, both unusual participant behavior in the previous day’s
markets and anomalous patterns that repeat themselves over time.
Individual analysts follow up on these items, either resolving them or
flagging them for further work. This further work can include short
studies, the development of new analytic tools, or reporting to other parts
of the Commission for further action. Representatives of the Division of
Investigations and the Division of Audits periodically attend daily
meetings. This allows the investigations and audits staff to stay current
with market developments that may affect current investigations and
audits as well as giving a first indication of issues that may come up in the
future. Under the Commission’s rules and practices, the investigations
and audit staff can initiate a preliminary non-public investigation or
commence an audit based on information gleaned from market oversight
activities.

Periodically through the year, the market oversight program also considers
trends over longer time frames. These longer-term examinations of
energy markets build on the insights gained in the daily oversight
meetings. The Commission’s experience shows that only intensive

- 83 -
 FY 2009 Performance Budget Request
Enforcement: Provide Vigilant Oversight
_____________________________________________________________________________________________________________________

involvement in day-to-day energy markets allows a strong understanding

of longer-term issues.

Remedying Potential Market Problems. The market oversight program

reports its findings to other groups that are charged to address the
problems identified. The key forms of reporting are to the senior
management of the Office of Enforcement, to other relevant offices within
the Commission, to the Commission itself, and to the public.

Reports to the senior management of the Office of Enforcement. In the

first instance, market oversight is an integral part of the Commission’s
overall Enforcement program. Market oversight, therefore, reports any
potential problems with market participant behavior to the senior staff of
the Office, which then decides which problems to refer for investigation
(by the Division of Investigations) or audit (by the Division of Audits).
These investigations and audits then address serious market participant
problems in the most appropriate way.

Reports to other Commission Offices. The Office of Enforcement ensures

compliance with existing rules and operations. When market oversight
observes potential problems with current practices, it reports its results to
those offices in the Commission that can develop Commission orders to
change existing tariffs or issue new Commission rules.

Reports to the Commission and the Public. Market oversight reports all of
its major findings to the Commission itself, as well as to the affected staff
offices. In January 2007, the Commission opened a Market Oversight
section on its website. This website includes a comprehensive set of
graphical reports on regional and national natural gas and electric markets,
along with reports on key related issues (e.g., fuels used in electric power
and emissions allowance markets). It also includes the compilations of
information used in monthly conference calls with state regulators, market
oversight reports to the Commission and other longer term reports.
Updates to the website are made monthly. Key reports to the Commission
and the public include:

! Weekly reports to the Commission. These document major

developments found during the week’s daily meetings. They also
describe any issues reported to other Commission staff.

! Twice a year, a seasonal assessment analyzes potential problems in the

coming peak season (either heating or cooling season) to alert both the
Commission and the public as to areas that need continuing attention.

! Annual reports on overall market performance. In the past, the

Commission has issued annual State of the Market reports with

- 84 -
 FY 2009 Performance Budget Request
Enforcement: Provide Vigilant Oversight
_____________________________________________________________________________________________________________________

detailed data for many energy markets and overall analysis of how
well the markets are working.

Energy Market Information. Both natural gas and electric power are
traded at many sites around the country, each with its own price and
volume behavior. Prices and market conditions change frequently, every
five minutes for many power markets. As a result, energy markets
generate vast quantities of raw data. The energy market oversight
program requires information support that includes:

! acquiring large volumes of data to reflect ongoing market conditions;

! validating the data to ensure that it is accurate and pertinent to the
issues being addressed;
! processing the data so that meaningful patterns become apparent;
despite the large volume of data that can easily become overwhelming;
and
! developing a real-time information capability to address rapidly
developing situations and emergencies.

The Commission’s energy market information capability addresses all of

these areas.

The Commission obtains a large quantity of publicly-available information

on all the markets it oversees. Most of these data come from commercial
information providers, and is the same information available to market
participants. It also uses the EQR, a record of every power sale by
jurisdictional electric companies.

The Commission validates information primarily by trying to use it to

understand markets. Experience shows that when data are not accurate or
pertinent, they come into conflict with other data sources. By observing
discrepancies among data sources, the Commission can assess the quality
of the information it obtains from all sources. This is a key reason that
analysts must share their insights widely – the daily meeting frequently
uncovers information issues that are then resolved. As a result, the
information available for future oversight continually improves over time.

The Commission’s market oversight staff works hard to visualize market

information to show important patterns. A stream of prices by itself is
almost meaningless. The Commission detects important patterns by, for
example, comparing related prices with each other, developing geographic
pictures of how markets inter-relate, developing timelines of important
incidents plotted against price changes, and creating threshold values for
further consideration. All of these efforts result in data interpretation tools
that the Commission then automates. The result is to let analysts spend as
much time as possible looking at important aspects of the markets, rather
than simply poring over lists of numbers.

- 85 -
 FY 2009 Performance Budget Request
Enforcement: Provide Vigilant Oversight
_____________________________________________________________________________________________________________________

The Market Monitoring Center (MMC), where Commission staff can

access most of the real-time and other data subscribed to from information
providers, is a hub of data collecting and analysis for Commission
research staff and a “must-visit” for foreign and domestic visitors engaged
in or contemplating monitoring their energy markets. In FY 2007, more
than 50 groups were briefed on the MMC functions and operations by
Commission staff. These groups included more than 515 individuals from
more than 30 countries. Staff from the U.S. Congress, state commissions,
federal agencies, and other energy-related agencies and organizations were
also given tours of the MMC in conjunction with appropriate briefings.

In April 2007, the Commission acted to implement the transparency

provisions of section 316 of EPAct by proposing new rules to improve
transparency in natural gas markets. In December 2007, the Commission
issued a final rule for market participants to report annually their annual
volume of physical natural gas transactions and the pricing methods used
in those transactions. Also in December 2007, the Commission issued a
second notice of proposed rulemaking for interstate and major, non-
interstate pipelines to post daily the capacity, scheduled flow volumes and
actual flow volumes for major receipt and delivery points. This
information would provide a more complete picture of natural gas supply
and demand throughout the United States.

The Commission continues to address transparency issues in wholesale

electric markets. It collects basic information about all jurisdictional
electric transactions in the EQR and makes this information available to
the public. RTOs and ISOs report a wide variety of market-related
information, including both day-ahead and real-time prices, in near real-
time. In its final rule reforming the open access transmission tariff, the
Commission increased the transparency of a transmission provider’s
transmission planning, its calculations of ATC, and its business rules and
practices. Going forward, the Commission is considering transparency in
wholesale electric markets in the broader context of competition in those
markets.

In FY 2007, the Commission increased its interactions with state and

federal energy agencies by instituting the Research in Market Oversight
(RIMO) program. Under this program, representatives from state and
federal government agencies come to the Commission for a week to
research an energy market issue of importance in partnership with the
Commission’s Market Oversight staff. The first RIMO project in April
2007 saw five representatives from Wyoming (including three aides to the
Governor) study the effect of natural gas pipeline grid prices paid to
Wyoming producers. In early June 2007, a staff member of the California
Public Utilities Commission studied episodes of high prices in various
Regional Transmission Organizations. In late June 2007, three staff
members of the Public Utilities Commission of Ohio spent a week testing

- 86 -
 FY 2009 Performance Budget Request
Enforcement: Provide Vigilant Oversight
_____________________________________________________________________________________________________________________

and improving modeling techniques they use to analyze power markets in

their state. The fourth RIMO group, staff from the Environmental
Protection Agency’s Clean Air Markets Division, arrived in early
December 2007, to study market connections between electric, natural gas,
coal and emissions markets. Staff from the Missouri Public Service
Commission is planning to participate in the RIMO program in January
2008. The Commission anticipates hosting at least four RIMO projects
each year.

The RIMO program complements an ongoing program in which the

Commission makes available to state energy agencies information on
energy markets including prices and supplies of natural gas and electric
power, and related developments including LNG facilities planned and
under construction, coal and oil market fundamentals, weather
implications and an analysis of observed changes over the month. The
program provides for a monthly regional phone discussion open to
representatives of various state regulatory agencies. The discussion covers
other energy issues that the regional agencies wish to discuss. This
outreach program started out modestly and has now grown to over 40
participating state and federal agencies, 5 regional energy organizations
and British Columbia.

Strategy

Performance Measure Target Data Source

Identify and remedy problems with structure and operations in energy markets

Regular monitoring of natural

gas and electric markets with Weekly reporting of significant
significant issues of market issues of market structure and Office of Enforcement
structure and operations operations
identified

Timeliness of actions on
Office of Enforcement / Office
significant issues identified by Within 6 months of completed
of Energy Market Regulation /
regular monitoring of natural report
Office of the General Counsel
gas and electric markets

Fully implement the Research

Perform at least four RIMO
in Market Oversight (RIMO) Office of Enforcement
projects per year
program

- 87 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

Allocation of Enforcement Resources

Objective B: Provide Firm but Fair Enforcement
(Dollars in Thousands)

FY 2007 FY 2008 FY 2009

Actual Estimate Request
Funding 7,565 22,285 25,305
Program 4,468 18,553 21,196
Support 3,097 3,732 4,109
FTEs 104 123 138
Program 84 101 114
Support 20 22 24

Objective B: Provide Firm but Fair Enforcement

EPAct 2005 greatly expanded the Commission’s enforcement authority to
enable the agency to penalize electric and natural gas companies where
penalties were unavailable before and to police market manipulation by
any entity and gave the Commission vast new authority to oversee the
reliability of the interstate electricity grid. The Commission’s request
includes an additional 13 FTEs and $2.6 million for the enforcement
program to handle these increased responsibilities.

In light of the new authorities granted the Commission by EPAct 2005, the
Commission has taken a number of steps to craft a cohesive approach to
enforcement, built around the central theme that Commission enforcement
actions will be firm but fair. This basic approach to enforcement was
explained in the Policy Statement on Enforcement, which outlined factors
the Commission will consider when assessing civil penalties or developing
remedies for violations of the statutes, orders, rules and regulations the
Commission administers. The Policy Statement provides comprehensive
guidance, consistent with the enforcement practices of other federal
agencies, to entities subject to the jurisdiction of the Commission.

The Policy Statement also identifies factors to be weighed in determining

the seriousness of the violation, and indicates what consideration will be
given for mitigating factors, such as adopting strong internal compliance
programs, voluntarily reporting violations, and cooperating with staff
investigations. The Commission is committed to using the full range of
remedies available including civil penalties, disgorgement of unjust
profits, or conditioning, revocation, or suspension of authorizations, but to

- 88 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

exercise discretion to apply such penalties and remedies in a fair,

reasonable, and appropriate manner.

In addition to the Policy Statement, the Commission has codified

important rules, including the prohibition of energy market manipulation
and the revision and codification of the Market Behavior Rules. The
Commission has provided greater due process to industry, including
providing a no-action letter process and increasing the opportunities for
companies to resolve disputed matters during the course of an audit. Thus,
while placing entities on notice that the Commission’s rules and
regulations will be enforced vigorously and even-handedly, the
Commission also has provided more transparency about the rules it
enforces and greater opportunities for entities to seek guidance about how
the rules apply to them.

Objective B Establish Clear and Fair Processes

Strategy 1
In EPAct 2005, Congress amended the NGA and FPA to prohibit the use
of manipulative or deceptive devices or contrivances by any entity in
connection with the purchase or sale of electric energy, natural gas, or
transmission or transportation services subject to the jurisdiction of the
Commission. The Commission provided guidance to the industry on how
it intends to use its new authority in the Policy Statement on Enforcement.
In this Policy Statement, the Commission emphasized it will be firm but
fair in enforcement actions, and that companies will be given credit for
proactive programs to assure compliance with the Commission’s rules,
regulations, and orders.

In addition, the Commission issued a final rule in new Part 1c of the

Commission’s regulations adopting new regulations to implement the
statutory anti-manipulation authority. The new rules are modeled on Rule
10b-5 of the Securities and Exchange Commission, and make it unlawful
for any entity, directly or indirectly, (1) to use or employ any device,
scheme, or artifice to defraud, (2) to make any untrue statement of a
material fact or to omit to state a material fact necessary in order to make
the statements made, in the light of the circumstances under which they
were made, not misleading, or (3) to engage in any act, practice, or course
of business that operates or would operate as a fraud or deceit.

Following the adoption of the new anti-manipulation rule, the

Commission in Order No. 674 revised its Market Behavior Rules by
rescinding Market Behavior Rule 2 as no longer necessary and codified
Market Behavior Rules 1, 3, 4, and 5 in Part 35 of the Commission’s
regulations. Market Behavior Rule 6 was also rescinded as duplicative of
existing requirements.

- 89 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

In addition, the Commission amended its regulations in Parts 41, 158, 286,
and 349 to give additional rights to companies undergoing an operational
audit, such that they can contest proposed audit findings at the staff level
before final action by the Commission. The Commission also adopted a
no-action letter process to permit market participants to seek advice on
whether staff would recommend action against specific transactions in
light of the anti-manipulation rules, Market Behavior Rules, or Standards
of Conduct.

Another enforcement responsibility under new section 215 of the FPA is

the Commission’s authority to enforce reliability standards. The
Commission is responsible for reviewing enforcement actions taken by the
ERO, a self-regulatory organization. It is difficult to estimate how many
enforcement actions the ERO will take and how many of these would be
reviewed by the Commission. However, the Commission is also
authorized to initiate enforcement action on its own motion, which is a
new enforcement responsibility for the Commission. Additional resources
in this area will be critical so that the Commission is poised to take action
when necessary and provide a strong presence in the reliability standards
enforcement area.

In November of 2007, two years after the issuance of the Policy Statement
on Enforcement, the Commission held a public conference on enforcement
policy to provide interested persons an opportunity to comment on the
implementation of the Commission’s new penalty, anti-manipulation, and
electric reliability authorities. More than 1,900 persons attended or
observed the conference and several participants submitted proposed
changes in Commission enforcement practices. Post-conference comments
were encouraged and the Commission intends to seriously consider all
comments and proposals.

In addition to the activities above, the Commission has continued its

operational and financial audit program. In FY 2007, the Commission
completed 68 audits of energy companies, including 3 audits that were
considered for further investigative actions. The audited companies
included public utilities, natural gas pipelines and storage companies, and
oil pipelines. The audits focused on compliance with post-EPAct financial
securities orders, open access transmission tariff, interconnection rules,
gas tariff, wholesale fuel adjustment clause tariff, standards of conduct and
code of conduct compliance, cash management programs, electronic
quarterly reporting, OASIS and gas websites, Uniform System of
Accounts, market-based rate authority, and other blanket authorization and
filing requirements of the Commission.

The audits resulted in a variety of remedial actions. Among them were

requirements for companies to conduct periodic internal audits related to
the areas of noncompliance, to make refunds, to make correcting

- 90 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

accounting entries, to file tariff revisions, and to create and implement

stringent compliance plans. These compliance plans required the creation
of robust organizational, procedural, and process remedies.

The Commission’s audit staff monitored a public utility’s successful

completion of a new $25 million construction project to alleviate
congestion on the transmission system. Specifically, the public utility
increased transmission capacity to alleviate congestion on the Iowa-
Illinois border and in Central Iowa. This increased transmission capacity
benefited many entities in the Midwest, including a number of municipal
electricity providers.

Moreover, two Commission audits resulted in a public utility (1) paying

$1 million in refunds for fuel costs improperly recovered from wholesale
energy customers in fuel adjustment clause billings and (2) reducing utility
assets by $14 million to correct an overstatement in its balance sheet
stemming from accounting practices that did not comply with the
Commission’s regulations.

Audit staff also provided technical analysis on some major investigations

and played an integral role on several general Commission activities
including: the ERO rulemaking and budget proposal, the open access
transmission tariff reform rulemaking, and the PUHCA rulemaking on
accounting, reporting, and records retention requirements.

Audit staff is currently conducting audits related to: holding companies’

compliance with PUHCA requirements, ERO and Regional Entities’
compliance with Commission orders and regulation related to enforcement
of reliability standards, sellers of wholesale energy compliance with the
conditions of their market-based rate authority (MBRA), and jurisdictional
utilities’ compliance with their open access transmission tariff.

PUHCA Audits. The objectives of the PUHCA audits are to ensure

compliance with the PUHCA 2005 reporting and record retention
requirements, ensure that the centralized service company’s sale or other
provision of non-power goods and services to regulated public utilities or
natural gas companies is in compliance with Commission orders and the
PUHCA 2005 Uniform System of Accounts and record retention
requirements, and ensure that the regulated entities’ purchases and
accounting of non–power goods and services supplied by centralized
service companies are in compliance with the Uniform System of
Accounts.

Reliability Audits. Throughout 2006 and the early part of 2007, the
Commission worked to implement FPA section 215, a new provision
added by EPAct 2005 which establishes a system of mandatory,
enforceable bulk power system reliability standards under the

- 91 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

Commission’s oversight. The Commission has certified an ERO,

approved mandatory reliability standards as well as a compliance
monitoring and enforcement program (CMEP) to enforce those standards,
and accepted delegation agreements to allow Regional Entities to conduct
much of the CMEP. The Commission will audit the ERO and Regional
Entities’ compliance with the processes, practices, and procedures that
implement the CMEP and related reporting requirements. Audit staff is
also actively participating in various other Commission and industry
efforts related to reliability.

The MBRA and Open Access Transmission Tariff Audits. These audits
will address compliance with new rules and regulations coming out of the
Commission’s recently completed rulemaking. The MBRA audits will
assess compliance with certain areas of the revised standards prescribed in
Order No. 697, Market-Based Rates For Wholesale Sales Of Electric
Energy, Capacity And Ancillary Services By Public Utilities, including
restrictions on certain transactions with affiliates. Meanwhile, the open
access transmission audits will determine compliance with the new and
clarified requirements coming out of the Commission’s Order No. 890.
Specifically, the audits will determine whether transmission providers are
making the appropriate amount of transmission service available to third-
parties consistent with good utility practice and are posting all the
information required by Order No. 890 to ensure transparency of
transmission service offerings.

Objective B Conduct Investigations Promptly and Impose Penalties Where

Strategy 2 Appropriate

In competitive markets, participants constantly seek new profit

opportunities, but some participants may violate rules or manipulate
markets to reap unjust profits. To protect customers, the Commission
seeks to detect statutory or rule violations by thoroughly investigating
observed market anomalies, complaints, and referrals from RTOs and
ISOs. The Commission’s investigations focus on possible market
manipulation, undue discrimination or affiliate abuses, violations of rules
and tariffs, and referrals of misconduct in organized markets.
Investigations involve matters such as bidding practices by generators in
organized markets, whether generation resources have been withheld in
contravention of market rules, compliance with Commission Standards of
Conduct requirements, unlawful sharing of transmission information with
trading affiliates, trading intended to manipulate market prices, and
compliance with hydroelectric project rules and license conditions

Once the Commission identifies violations, it applies remedies to mitigate

the effects of the violations, requires disgorgement of unjust profits where
appropriate, imposes civil penalties or other sanctions when available
under existing laws, and requires compliance plans to prevent future

- 92 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

violations. Findings in particular cases can also serve as the basis for
changes in regulations to address market power or manipulation issues.
With the passage of EPAct 2005, the Commission was granted enhanced
civil penalty authority and a clear mandate to prevent market
manipulation. The Commission now has authority to impose civil
penalties of up to $1 million per day per violation for violations of rules,
regulations, and orders under the NGA and all of Part II of the FPA, and
up to $1 million per day per violation of the NGPA.

Since the beginning of FY 2007, the Commission has completed 45

investigations focusing on possible instances of market power and
manipulation, undue discrimination or affiliate abuses, violations of rules
and tariffs, orders, hydropower requirements, and license or certificate
conditions. Notably, the Commission issued an order on October 2, 2006,
completing action on an investigation concerning the breach of an upper
reservoir of the Taum Sauk hydroelectric project in Missouri. The
Commission approved a record hydropower settlement of $15 million,
including a $10 million civil penalty and a $5 million fund to provide
enhancements to the project area over and above remediation of the
damages from the breach. On January 18, 2007, the Commission
approved settlements in five matters that had been under investigation.
The settlements imposed a total of $22.5 million in civil penalties, the first
use of the expanded civil penalty authority provided to the Commission by
EPAct 2005. The penalties ranged from $10 million for multiple
violations by an electric utility of its open access transmission tariff and
the Commission’s Standards of Conduct to $500,000 for a violation of the
Market Behavior Rules by an electric utility that misrepresented a
generating unit’s availability.

Subsequently, the Commission issued orders on March 3, May 9, and May

21, 2007 approving settlements in 7 additional matters, imposing an
additional $17.3 million in civil penalties. Four of the orders provided for
penalties ranging from $300,000 to $7 million for self-reported violations
of the Commission’s natural gas capacity release program. Specifically,
the violations included violations of posting and bidding rules, the
“shipper-must-have-title” requirement, and the prohibition on buy/sell
transactions. The other three orders provided for penalties from $500,000
for failure to obtain Commission authorization prior to entering into
jurisdictional transactions, to $2 million for violation of a Commission
order.

On July 26, 2007, the Commission for the first time used its new
enforcement authority to prosecute market manipulation when it issued
show cause orders that made preliminary findings of market manipulation
and proposed civil penalties totaling $458 million in two investigations
involving traders’ unlawful actions in natural gas markets.

- 93 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

In addition, the Enforcement Hotline is a mechanism whereby industry

participants provide information to the Commission that may result in
investigations. During FY 2007, the Enforcement Hotline received 421
calls.

Finally, the Commission has increased its cooperation and sharing of

information with federal agencies having responsibility for regulation of
energy companies, including conducting joint investigations with other
agencies, such as the Commodity Futures Trading Commission and the
U.S. Department of Justice. Pursuant to EPAct 2005, the Commission and
the Commodity Futures Trading Commission executed an MOU relating
to sharing information on October 12, 2005 and are exchanging
enforcement information on a regular basis pursuant to the MOU.

Objective B Encourage Self-policing and -reporting of Violations

Strategy 3
The Commission has taken various steps to improve the self-reporting of
violations and the ability of companies to obtain clarification of their
obligations under Commission rules and regulations. These initiatives
involve providing more information and guidance on audit, investigation,
and compliance matters, including compliance with the Standards of
Conduct. As a result of these initiatives, the Commission:

! issued a Policy Statement on Enforcement, which set forth the

considerations the Commission will take into account in assessing civil
penalties, such as whether a company self-reported the violation and
whether the company had a compliance program in effect;
! issued orders establishing a no-action letter process;
! issued Order No. 670 to implement the prohibition on market
manipulation in EPAct 2005 as new Part 1c of the Commission’s
regulations;
! issued an order in Docket No. EL06-16-000 rescinding Market
Behavior Rules 2 and 6 in light of the new anti-manipulation rule
issued in Order No. 670;
! issued Order No. 673 to codify the remaining Market Behavior Rules
in Part 35 of the Commission’s regulations;
! issued Order No. 675 to provide additional due process to entities that
are subject to operational audits under Parts 41, 158, 286, and 349 of
the Commission’s regulations in the event they contest any of the
findings in the audit report;
! posted a comparison of rules and key enforcement documents to
provide clarity to market participants; and
! made information available on its web page that explains the audit
process, including answers to frequently asked questions regarding the
Standards of Conduct.

- 94 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

Self-reports began immediately after the issuance of the Policy Statement

on Enforcement. As of November 2007, the Commission has received 77
self-reports of violations of various Commission orders, rules, or
regulations. In many cases companies took self-corrective action before
making the self-report, and 45 self-reports involving less serious matters
have been closed without further action by the Commission, upon a
showing by the company that it is now in compliance. In more serious
matters, the Commission has imposed civil penalties for the violations
that were self-reported, but in determining the penalty amount, gave
significant credit to the company for having self-reported. The
Commission encourages companies to instill a strong culture of
compliance in their organizations, and to self-report violations promptly
and fully.

It is incumbent upon the Commission to ensure that its market, reliability,

and other regulatory rules are clear, enforceable and fully understood by
the jurisdictional entities that we regulate. However, the obligation to
comply with those regulations, rules and standards lies with the regulated
entity. Therefore, it is important that regulated entities have a rigorous
internal compliance program that provides them with the tools, processes,
and high-level management support to identify problems or areas of non-
compliance and to report such problems to the Commission. The
Commission needs to work with its regulated entities to help them
develop and maintain good compliance procedures such that any
necessary enforcement actions by the Commission (including penalties or
sanctions) are a regulatory tool of last resort – invoked only when the
compliance process has failed.

Strategy

Performance Measure Target Data Source

Establish clear and fair processes

Provide recommendations to
Apply current clear and fair the Commission for each
processes to investigations proposed remedy and penalty Office of Enforcement
during the fiscal year with clear and consistent
criteria

Timeliness of reporting to the

Within 120 days of the
Commission on operational Office of Enforcement
Commencement Letter
audits

Percentage of operational
audit recommendations 90% within 6 months Office of Enforcement
issued and implemented

Timeliness of reporting to the

Within 120 days of the
Commission on financial Office of Enforcement
Commencement Letter
audits

- 95 -
 FY 2009 Performance Budget Request
Enforcement: Provide Firm but Fair Enforcement
_____________________________________________________________________________________________________________________

Strategy

Performance Measure Target Data Source

Percentage of financial audit

recommendations issued and 90% within 6 months Office of Enforcement
implemented

Conduct investigations promptly and impose penalties where appropriate

Timeliness of initiating or Office of Enforcement / Office

deciding action on MMU 80% acted on within 30 days of Energy Market Regulation /
referrals Office of the General Counsel

Percentage of enforcement
investigations not involving 75% within one year of
Office of Enforcement
market manipulation issues initiation
completed
Percentage of market
75% within two years of
manipulation enforcement Office of Enforcement
initiation
investigations completed

Percentage of Hotline calls 70% within 2 weeks of initial

Office of Enforcement
resolved contact

Encourage self-policing and -reporting of violations

Percentage of regulated
entities audited to ensure 85% of regulated entities
Office of Enforcement
internal compliance programs included in annual audit plan
and processes are in place
Office of Enforcement/ Office
Process complete requests for Within 60 days of receipt of of the General Counsel /
“No Action” final request Office of Energy Market
Regulation
Timeliness of reporting on
compliance issues raised by Reports completed monthly Office of Enforcement
regulated entities

- 96 -