Penalty Shot


An interpretation of FERC’s first application of EPACT.

Fortnightly Magazine - April 2007

At its open meeting on Jan. 18, 2007, the Federal Energy Regulatory Commission (FERC) unanimously approved settlements with five electric utilities for a total of $22.5 million and other considerations (most notably commitments to effective compliance programs).

This action by the commission answers some important questions that energy market participants have been asking. In particular, the commission’s decision to issue multiple settlement orders at once helps market participants connect some important dots regarding the regulatory landscape in which they must operate, but it also raises important questions that market participants would like answered.

Overarching Lessons

The Energy Policy Act of 2005 (EPACT) gives FERC the authority to issue penalties of up to $1 million per day per violation. The financial penalties issued, through settlement agreements, varied from a high of $10 million to half a million dollars. Table 1 summarizes the penalties and briefly characterizes the alleged violations. FERC sought to enhance communication to the energy markets about its intent by discussing these settlements at its open meeting. The commission appeared acutely aware that the industry would draw lessons from these settlements.

Three lessons were particularly noteworthy. First, the commission’s action demonstrated its serious intent to enforce its rules. Although FERC has stated this clearly and repeatedly, some market participants had been in denial, believing the commission’s lack in exercising the new penalty authority would continue. Second, every commissioner emphasized the importance to herself or himself of “self-report” violations by market participants. The phrase “self report” was mentioned more than two dozen times. The third important lesson, addressed explicitly by the chairman, should be obvious to any energy executive: Although all five utilities were penalized for electricity matters, the commission is pursuing enforcement for all matters subject to its jurisdiction.

Key Factors

Lead attorney Robert Pease, director of FERC’s Investigations Division, and his deputy, Lee Anne Watson, presented the broad factors considered in determining a penalty and in a company’s efforts to remedy deficiencies in a timely manner.

They also mentioned “detailed factors” (see Table 2), including:

• Existence of a compliance program;
• Harm caused;
• Intent of manipulation or deceit;
• History of violations;
• Senior management involvement; and
• Speed of company action.

Each commissioner mentioned some of these factors. There were no surprises in this discussion. In fact, anyone who has read the commission’s enforcement policy statement would have been quite familiar with the factors discussed.

These factors will inform a wise leader’s development of a company’s compliance program and efforts to promote a culture of compliance.

Two Categories

There are at least two other sets of lessons that can be drawn from this policy action:

• Other lessons for market participants; and
• Lessons FERC or other energy policy-makers may draw from this exercise.

Lessons for Market Participants. FERC’s actions indicate a focus on promoting competitive pressures through ensuring access to transmission services (PacifiCorp, SCANA, Entergy, NorthWestern) and market integrity (NRG). With regard to transmission access, the commission imposed penalties from $1 million to $10 million for alleged violations resulting in relatively minor estimated harm. A closely related point, easily inferred from the open meeting discussion, is that violations that cause harm will incur significantly more serious penalties. For a “ballpark” estimate, a participant could look at the SCANA case. There, FERC required SCANA to disgorge $1.4 million and about $0.4 million disbursed to ratepayers. Assuming this represents FERC’s estimate of harm caused, the penalties were five times the harm. As commissioners said more than once, this was the calculus of punishment in this first instance. Their inclination to use prosecutorial discretion to reduce harsh penalties likely will deteriorate over time and with repeat offenses.

Another important development was not discussed at the Jan. 18 open meeting but was reported in the PacifiCorp Order.1 PacifiCorp must make an accounting transfer of approximately $86.5 million because payments in this amount should have been made by PacifiCorp’s merchant function. Although the net effect of this transfer was zero, this element of the settlement shows the commission’s readiness to make determinations regarding funds far in excess of the $10 million maximum penalty issued on Jan. 18.

With regard to NRG, many market participants are alarmed by this penalty. Although it was the smallest penalty, it was imposed for a single violation, and the company appeared to have done “the right things.” NRG had:

• Self-reported;
• Terminated two employees who violated company “practices or protocols”;
• Provided “exemplary cooperation”; and
• Had not profited from the violations.

Nevertheless, NRG received a civil penalty of half a million dollars.

Without more explanation from the relevant parties, the main lesson I would draw from this is that reporting about generator status is of the utmost importance to electric power capacity market integrity. Therefore, this breach of integrity and alleged violation of the ISO New England (ISO-NE) tariff and Market Behavior Rules 1 and 3 received a relatively stiff penalty. Another important factor is that the ISO discovered the “down” status of the generation facility on its own initiative. Based on the information in the stipulation and consent agreement, ISO-NE’s test dispatch appears to have started the chain of events that led to NRG’s self-report.

Lessons for Policy-makers. Perhaps the most important finding from this first set of penalty cases involves the progress the jurisdictional energy markets appear to have made. When FERC began building its new market oversight and enforcement capabilities, the relevant markets were in chaos from a white collar riot. That the commission considered these cases, as a group, ripe for presentation to the industry suggests important progress in the return of jurisdictional markets to respect for FERC’s rules.

Of course, bigger, higher-stakes cases may take longer to bring to closure. Therefore, this conclusion could prove fleeting. Nevertheless, the commission decided to bring these public and discuss them in public, and that is adequate basis to conclude that they have addressed behaviors they consider important to today’s jurisdictional markets.

Unanswered Concerns

Despite FERC’s efforts to communicate with market participants about appropriate behavior, the actions on these initial settlements already have created as many questions as they answered.

For example, are all of the more than 40 self-reporting incidents mentioned repeatedly at the Jan. 18 meeting resolved? If some are not resolved, are the remaining cases a “random mix” or cases of greater seriousness? What is the nature of the kinds of matters reported that were not penalized?

If the NRG alleged violations were the result of the “actions of a single employee,” 2 why were two employees terminated? 3

FERC now has acted forcefully to demonstrate its resolve to enforce its regulations. The market can expect more enforcement actions. Questions remain, but a prudent executive will make certain the company is building a culture of compliance around its energy markets and reliability practices that will pass regulators’ review because the Kelliher Commission has shown its intent to make the costs of disobedience prohibitive.



1. PacifiCorp, Order Approving Stipulation and Consent Agreement, Docket No. IN07-5-000 at 3 (Jan. 18, 2007).

2. FERC, Press Release, Jan. 18, 2007, p. 3.

3. NRG Energy Inc., Order Approving Stipulation and Consent Agreement, Docket No. IN07-6-000 at 2 (Jan. 18, 2007).