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ISOs as Market Regulators The Emerging Debate

Fortnightly Magazine - April 15 1998

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Seizing on PECO's objection, other critics have come forward. Those who question the growing role of ISOs in monitoring and mitigating possible market abuses now speak of an "ISO-centered regulatory regime" %n18%n:

1. Unlike traditional cost-based utility regulation, which takes the form of administrative agency review of prices proposed in advance, ISO monitoring and mitigation plans evaluate data on completed transactions and impose sanctions against sellers whose conduct is deemed improper. ISOs must therefore make post hoc judgments about the behavior of sellers in a competitive market.

2. By allowing ISOs to perform regulatory functions, the FERC may have engaged in unconstitutional delegation of governmental authority to private entities, whose discretion to investigate and apply broadly defined standards of conduct threatens the due process rights of market participants.

3. Sellers subject to investigation, price limitations and potential sanctions for prior misconduct will be inhibited; competitive market behavior will be chilled. The distinction between permissibly aggressive competitive pricing behavior and unlawful conduct is subjective and has not been adequately defined by decisional law or regulations.

4. Traditional antitrust analysis should be used to judge market power concerns. An ISO's mitigation procedures should be limited to must-run situations and to avoid exercising discretion.

The Choice:

More Government Or Self-Regulation?

Self-regulating ISOs are hardly a novelty, nor should they represent any insidious bureaucratic encroachment on free markets. ISOs are in use in Canada and Australia. In each instance, as in the U.S., a practical consideration has motivated the decision to allow self-regulation: The government plainly lacks the resources and expertise to sustain an ongoing program of monitoring and mitigation. %n19%n Effective self-governance through an ISO reduces the need for external regulation. The philosophical choice is not between unfettered competition and self-regulation; it is between self-regulation and government regulation or forced divestiture. As long as residual market power exists, self-regulation can facilitate oversight at lower cost and with less intrusion on competition than government regulation.

Self-regulation works in other markets. Federal law requires self-regulation by securities exchanges, which retain the obligation to formulate rules governing the conduct of exchange members and to police themselves for fraud, deception and price manipulation. In the event abuses are found, an exchange can suspend or expel members.

For example, NASD Regulation Inc., a subsidiary of the National Association of Securities Dealers, is charged with monitoring the NASDAQ market to spot insider trading, price fixing and other market abuses. NASD uses automated market surveillance systems to look for unusual price and volume movements. Monitoring leads to formal investigations and referrals to the Securities and Exchange Commission, called "'the shotgun behind the door,' ready to be used but with the hope that it would never have to be used." %n20%n

Self-regulation need not imply unlawful delegation of legislative authority to private entities, such as ISOs. The devil, as always, is in the details. To withstand constitutional scrutiny, ISOs must employ "pre-established objective criteria" %n21%n to run monitoring and mitigation programs. Objectivity will be served if the ISO follows an "intelligible principle" %n22%n in exercising authority coupled, of course, with adherence to