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Proving Intent to Manipulate Markets

Should FERC look to all Securities and Exchange Commission precedent for a model?

Fortnightly Magazine - May 2006

the Exchange Act, and Order 670 regulations are patterned after SEC Rule 10b-5. 7 Order 670 insists the scienter element will apply just as it applies to SEC Rule 10b-5. 8 Therefore, precedents on the PSLRA strong-inference-of-scienter standard appear to be available without difficulty for use in identifying and preventing energy market manipulations and frauds.

On the other hand, FERC conceivably could reject the PSLRA strong inference standard as appropriate only for securities law actions brought to court by private individuals, perhaps finding the PSLRA scienter standard either inapplicable or applicable only to a lesser degree for purposes of FERC’s own administrative enforcement actions. Determining it illogical to ignore decades of useful guidance that securities precedents offer, Order 670 nevertheless recognizes that the FERC mission to protect purchasers from unjust and unreasonable rates and services differs from the SEC mission to assure a regime of disclosure for security purchases. 9 Both EPACT and Order 670 avoid creating private rights of action, leaving FERC administrative action as the only procedural avenue against energy market manipulation. 10 Private litigation is common under the securities laws, but an Order 670 footnote says that while such cases “may be instructive on certain points, the elements needed for a private right of action are not the same as those required” for FERC administrative enforcement action. 11

FERC Requirements

In Ernst & Ernst v. Hochfelder, the U.S. Supreme Court held that a private lawsuit for damages under §10(b) and Rule 10b-5 requires allegation of scienter. 12 Also, the words “manipulative,” “device,” and “contrivance” make unmistakable congressional proscription of a type of conduct quite different from negligence. 13 Finally, scienter must be established as an element of the SEC’s own civil enforcement actions to enjoin violations of §10 (b) and Rule 10b-5. Aaron v. SEC, 446 U.S. 680, 682-84, 701-02 (1980). Order 670 echoes those rulings by declaring that any energy industry market manipulation violation requires a showing of scienter, relying on appellate court rulings to conclude that recklessness satisfies the scienter element as well.

Copious PSLRA Precedent

Securities case law evaluating private rights of action under the PSLRA strong-inference-of-scienter test distinguishes intentional or reckless scienter from merely negligent practices or corporate mismanagement. But what is such scienter? How can it be recognized? As one federal judge observes, concrete guidance on what constitutes recklessness can be gleaned by looking to the facts in those cases in which pleadings have been analyzed. 14 Whether the scienter allegations fail or succeed, such securities case law can instruct FERC enforcement analysis, as follows.

• Motive and opportunity, or recklessness, must be shown. Securities precedents where scienter is not alleged cogently can transfer readily to the energy industries. For corporate executive scienter, a person’s job description is not enough. Facts must link the executive with culpable behavior, or scienter is not shown. The scienter starting point is to require factual indication of motive, such as concrete benefits to the defendants, and of opportunity, or means and prospect of achieving those benefits. In re Dynex Capital, No. 05 Civ. 1897, 2006 U.S. Dist. LEXIS