Penalty Predictability Enhanced

Deck: 

FERC modifies its enforcement guidelines.

Fortnightly Magazine - November 2010

In 2005, the U.S. Congress increased Federal Energy Regulatory Commission (FERC) penalty authority over the country’s natural gas pipeline and electric utility industries. Five years later, FERC implemented September 2010 modified policy guidelines (guidelines) to assess civil penalties under that authority, once it has determined that a violation has occurred and a penalty is warranted. These civil penalty guidelines follow on the heels of proposed such guidelines issued in March 2010 that were the subject of an earlier article (See “Penalty Predictability,” Fortnightly, July 2010.) The final guidelines, summarized here, merit industry scrutiny.

The Energy Policy Act of 2005 (EPAct 2005) gave FERC greater civil and criminal penalty authority. For example, gas and electric industry violators face these maximum civil monetary penalties: Under the Natural Gas Act (NGA)—$1 million per day per violation for as long as the violation continues; under the Natural Gas Policy Act of 1978 (NGPA)—$1 million for any one violation; and under the Federal Power Act (FPA)—$1 million for each day that such violation continues.1 FERC’s Sept. 17, 2010, revised policy statement and attached penalty guidelines2 modify previously proposed guidelines in important ways.

Guidelines From 10,000 Feet

FERC’s civil penalty authority under the NGA, NGPA, and FPA should be exercised with care, based on experience, to provide fairly for just punishment and deterrence. The guidelines repeatedly make plain that FERC’s analysis is influenced in part by an ongoing public dialog with affected industries.3 FERC promotes increased consistency, transparency, and fairness in its monetary and non-monetary penalty assessments when organizations violate the statutes, orders, rules, regulations, and approved tariffs or statements of operating conditions that FERC oversees. The guidelines, modified from proposals made available for public comment in early 2010,4 add consistency to the penalty assessment process because penalties are to be based on more objective, specified factors, which are assigned transparent values and are uniformly weighted for similar violations and similar violators.

Effective Sept. 17, 2010, the guidelines attached to FERC’s revised policy statement enhance penalty predictability for gas and electric industry organizations; however, FERC’s discretion to make individual penalty assessments based on a given case’s facts also remains unrestricted. If multiple acts of misrepresentations, or of fraud, anti-competitive conduct, and other rule, tariff, or order violations occur, FERC on a case-by-case basis can use the guidelines to treat each act as a separate violation, but will take the cumulative harm of the multiple violations into account to determine a penalty. If multiple acts of electricity reliability violations occur related to the same conduct or event, FERC on a case-by-case basis can use the guidelines based on the conduct as a whole. FERC sees the civil penalty guidelines as motivating organizations to devote significant efforts to develop and maintain sufficient compliance measures. FERC repeatedly declares compliance, not penalty assessment, to be its central enforcement goal.5

Guidelines Chapter & Verse

Chapter 1 of the guidelines consists of one part stating general principles of applicability, § 1A1.1, and other parts discussing disgorging gain from violations and describing how to conduct an effective compliance program, §§ 1B1.1 & 1B2.1. Along with Chapter 2 (§§ 2A1.1 to 2C1.1), Chapter 1 also determines and implements civil penalties step-by-step, §§ 1C1.1 to 1C2.3. As the NGA and FPA require, the guidelines consider first the nature and seriousness of the violation, and then make any adjustments for culpability or efforts at remediation.6

Chapter 2 of the guidelines specifies base violation levels for three different types of serious violations: misrepresentations, market or other violations, and electricity reliability. The base violation level is the starting place to estimate the seriousness of the violation, and also for enforcement staff penalty recommendations or FERC penalty determinations. Chapter 1 then provides various factors to adjust the Chapter 2 base violation levels, as may be applicable to define the seriousness more accurately.

Intentional or reckless misrepresentations and false statements to FERC or its staff, as the most serious violations, are assigned the highest base violation level (18), § 2C1.1. This guideline is modified to apply only to intentional or reckless acts, with an increased prosecutorial burden on enforcement staff to prove such scienter.7 It doesn’t apply to inadvertent errors in filings, such as tariff or posting errors not presenting serious threats to market transparency, or to communications not aimed to mislead FERC or its staff. Specific violation characteristics for misrepresentations include substantial interference with the administration of justice (i.e., add 3 levels), and destruction, alteration, or fabrication of a substantial number of records, documents, or tangible objects; selection of essential or especially probative records, documents, or tangible objects for destruction or alteration; or a violation otherwise extensive in scope, planning, or preparation (add 2 levels).

A base violation level of 6 applies to violations of fraud, anti-competitive conduct, and other rule, tariff, or order violations, § 2B1.1. Specific violation characteristics include more levels for greater dollar losses. Sixteen stages for loss range from $5,000 or less (no level increase) to more than $400 million (add 30 levels), § 2B1.1(b)(1). A violation involving greater quantities of gas or electricity adds 2-6 levels, depending on the volume of loss, § 2B1.1(b)(2), and a violation continuing for more than 10, 50, or 250 days also adds 2-6 levels, § 2B1.1(b)(2). Thus, an organization committing a fraudulent act (6 levels) with a dollar loss amount (add 0-30 levels), and a quantity of gas or electricity lost (add 2-6 more levels) over the course of a number of days (add 2-6 more levels) could have a final violation levels total between 10 and 48. Furthermore, conduct presenting a serious threat to market transparency independently requires a minimum violation level of 16, § 2B1.1(b)(3).

Serious Reliability Violations

Considering its EPAct 2005 authority, agency discretion, and public comments,8 FERC reduces the base violation level for § 2A1.1 violations of FERC-approved, electric industry reliability standards from 16 to 6. FERC makes that modification and others, including changing certain risk of harm enhancements, for its own enforcement and 18 C.F.R. Part 1b investigation purposes against electric industry users, owners, or operators. Those purposes are separate from North American Electric Reliability Corp. (NERC) enforcement processes. FERC will not apply its penalty guidelines to its review of NERC notices of penalty and FERC does not intend to investigate minor reliability violations involving little or no harm or risk of harm. FERC’s belief is that the guidelines will deal effectively with violations seriously impacting bulk-power system reliability.

Balancing the need to deter reliability violations and promote compliance with a recognition that less-severe violations should receive smaller penalties, the revised policy statement modifies certain base violation levels, risk-of-harm adjustments including modifications to the specific violation characteristic categories for risk of loss, total violation levels, and base penalties. The revised policy statement includes a comparative table presenting the several modifications.9 The interactions of those new factors modify the guidelines’ risk-of-harm adjustments to provide a smaller base penalty range for facts of low risk of minor harm ($5,000) to moderate risk of major harm ($2.1 million), while not modifying the base penalty range for the most serious violations, from low risk of extreme harm ($6.3 million) to high risk of extreme harm ($17.5 million).

With respect to loss of electricity load, the revised policy statement says FERC won’t make individual assessments of loss-of-load value as a measure of a violation’s harm because they require substantial time and resources by both the electric industry entity and FERC staff.10 Instead, the guidelines use the quantity of load lost in megawatt hours (MWh) as a measure of seriousness. The 11 quantity categories range from a loss of less than 10 MWh of firm load (no level increase) to a loss of 10,000 or more MWh of firm load (add 32 levels). FERC rejects a suggestion to dispense entirely with loss-of-load data to calculate penalties for reliability violations, explaining that it continues to treat violations involving loss of load more seriously than non-blackout violations. FERC will consider loss of load when there is a causal connection between the load lost and a reliability standards violation, but not when a reliability standard requires load to be shed, for instance, to avoid cascading outages.

Once the final violation level for the type of violation (e.g., misrepresentation, market or other, or reliability) is determined, that level, § 1C2.1, is matched to a base-penalty dollar amount from the violation level penalty table, § 1C2.2(b). Alternatively, the base-penalty amount is increased to the level of the pecuniary gain to the organization or the pecuniary loss caused by the organization, § 1C2.2(a)(2)-(3), if that dollar amount is greater than the base penalty. This civil-penalty assessment mechanism in the guidelines doesn’t affect FERC’s practice to require disgorgement of unjust profits by entering orders for the full amount of such gains plus interest, § 1B1.1. Nor has FERC let go of its discretion to assess non-monetary sanctions, either to replace or accompany monetary penalties, such as requiring entities to submit compliance monitoring reports or to conduct audits.

Other Considerations

After the base penalty is determined, the guidelines next turn to the degree of the violator organization’s culpability and any violator remediation. Those important factors can raise or lower the guidelines’ ultimate penalty fine ranges significantly.

An initial, 5-point base culpability score, § 1C2.3(a), can be adjusted up or down based on an organization’s past and present conduct and its efforts to remedy the violation—that is, the 5-point score can be increased, offset, or even eliminated. Also, FERC enforcement staff retains its discretion to close self-reports or investigations without sanctions. For relatively minor violations resulting in little or no harm, staff may do so with no sanctions even when a violation has occurred. Zero dollar penalties are possible.

Culpability Under § 1C2.3(b)-(e)11: Based on the number of the organization’s employees, from 1-5 points may be added to the base culpability score if high-level personnel or those in substantial authority participated in, condoned, willfully were ignorant of, or tolerated the violation. FERC makes prior history determinations concerning either prior FERC adjudication or settlement of any violation, or adjudication of a similar violation by any other enforcement agency. If the organization re-committed any part of the prior misconduct in less than 10 years, or in less than 5 years, 1 or 2 points may be added, respectively. FERC focuses both on the number of prior violations and the rate at which they were committed, case-by-case. Two points may be added for the violation of a judicial, FERC, or other federal or state enforcement agency remedial or enforcement order or injunction directed at the organization and related to the misconduct at issue in FERC’s enforcement action or investigation. Three points may be added if the organization willfully obstructed or impeded justice, or encouraged obstruction during investigation or resolution of the violation, or knew of such obstruction or impedance but failed to take reasonable steps to prevent it. FERC also can assess a higher penalty for an entity that lacks an effective compliance program, or has a widespread disregard for, or little or no culture of, compliance. Further, the guidelines don’t affect FERC’s ability to consider the appropriateness of an organization’s record retention and electronic recordkeeping.

Remediation Under § 1C2.3(f)-(g)12 : Up to 3 points may be subtracted from the base culpability score if an effective compliance program was in place at the time of the violation, including effective yet imperfect compliance programs. Larger organizations should be able to devote more formal operations and greater resources to compliance, and FERC assesses the effective- ness of compliance programs on that basis. FERC removes an earlier provision automatically eliminating such compliance point credits where high-level personnel, or those in substantial authority, or individuals with operational responsibility for compliance participated in, condoned, or were willfully ignorant of the violation. As modified, the guidelines now declare that even where there is senior-level personnel involvement, FERC won’t automatically eliminate all compliance credit. If the senior-level person acted on his or her own, perhaps as a rogue employee, that can support granting credit. If said employee acted at the direction, or under the supervision, or with tacit acquiescence of the organization’s governing authority, that can support denying credit.

Also, credits for several mitigation factors no longer are tied together on an all-or-nothing basis. As modified, each carries value to be independently credited or not. Two points may be subtracted from the base culpability score for a voluntarily disclosed self-report, made without unreasonable delay, reasonably promptly after becoming aware of the violation, and prior to an imminent threat of disclosure or government investigation. However, the guidelines contemplate that an organization will be allowed a reasonable period of time to conduct an internal investigation. Next, 1 point may be subtracted for full, consistent, continuing cooperation with enforcement staff. Cooperation credit will not be lost for a violator’s good faith legal or factual arguments, or its good faith objections to data requests. Finally, 1 point may be subtracted for resolving the matter without a trial-type hearing, the absence of which saves FERC time and resources, and 1 point also may be subtracted for a violator’s affirmative acceptance of responsibility for the violation.

Penalty Fine Range: Those culpability and remediation adjustments either increase or decrease the violator’s 5-point base culpability score, determining a final, § 1C2.3 culpability score that corresponds to the important § 1C2.4 minimum and maximum penalty multipliers. A corresponding § 1C2.5 guideline penalty fine range for organizations results from multiplying the base penalty amount and the applicable penalty multipliers. Thus, an ultimate possible penalty fine range results, based on the earlier-determined final violation level and the earlier-determined degree of culpability or remediation calculation. That penalty fine range isn’t mandatory for FERC, but is fully subject to FERC discretion and flexibility as to the facts of each case.

Full FERC Flexibility

While the guidelines-based approach doesn’t restrict FERC discretion to make an individualized assessment based on the facts of a given case, the discipline of using objective guidelines factors in the first place, or during the civil-penalty assessment process, or simply the guidelines’ existence as a set of generic standards for comparison purposes, should nevertheless still result in more predictable NGA, NGPA, and FPA penalty decision-making. When the agency imposes its discretion, departing up or down from a guidelines-determined penalty fine range, the revised policy statement confirms that FERC will place on the public record the considerations that caused it to conclude such departure was appropriate. Significantly, only FERC, not its staff, can authorize departure from the guidelines, and FERC can do so regardless of staff recommendations.

Using the guidelines’ more consistent and objective characteristics to determine possible penalty fine ranges serves the public interest by enhancing penalty predictability for NGA, NGPA, or FPA violations. The guidelines make FERC’s exercise of its EPAct 2005 penalty authority more transparent. Working through such detailed guidelines mechanics should help to ensure fair FERC civil penalty assessments.

 

Endnotes:

1. 15 U.S.C. § 717t-1(a) (NGA) ; 15 U.S.C. § 3414(b)(6)(A) (NGPA); 16 U.S.C. § 825o-1(b) (FPA). EPAct 2005 also increased criminal penalties, including fines and prison terms, for NGA, NGPA, and FPA violations. J. Michel Marcoux, “Day Of Decision For FERC,” 143 Public Utilities Fortnightly, No. 12, December 2005, pp. 55, 58 (“Stiff New Penalties” chart).

2. Enforcement of Statutes, Orders, Rules, and Regulations, Revised Policy Statement on Penalty Guidelines, 132 FERC ¶ 61,216 (2010) (revised policy statement), text paras. (PP) 1-9, 97, 175-76, 182-83, 191-94, 216, 222 & 228.

3. Revised policy statement, PP 1, 210-11, 226 & 229; Statement of Chairman Jon Wellinghoff on Revised Penalty Guidelines, Dkt. No. PL10-4-000 (Sept. 16, 2010) describing enforcement staff consideration of public comments and stressing FERC openness to making further adjustments at a 2011 public technical conference. Another senior official observes that a “meeting of the minds” with industry would be appreciated. Thomas R. Sheets, General Counsel, FERC, Remarks at Bruder, Gentile, & Marcoux, L.L.P.’s 16th Annual FERC Briefing, Wash., D.C. (May 6, 2010).

4. Enforcement of Statutes, Orders, Rules, and Regulations, Policy Statement On Penalty Guidelines,130 FERC ¶ 61,220, PP 1-2, 5 (Mar. 18, 2010) (interim policy statement & proposed penalty guidelines); Order Regarding Policy Statement On Penalty Guidelines, 131 FERC ¶ 61,040 (2010). See also Marcoux, “Penalty Predictability,” 148 Public Utilities Fortnightly, No. 7, July 2010, pp. 16-19 (reviewing Mar. 2010 interim policy statement & proposed penalty guidelines).

5. Penalty guidelines, §§ 1A1.1.2, 1B2.1; revised policy statement, PP 109-113; accord Larry R. Parkinson, Director, Div. of Investigations, Off. of Enforcement, Remarks at Energy Bar Ass’n Nat. Gas Reg. & Compliance & Enforcement Comms. Seminar & Teleconference “Current Enforcement Perspectives,” Wash., D.C. (May 17, 2010) (“The first and foremost goal is to foster compliance . . . in the market arenas,” which are “any place that attracts a great deal of money . . . . Industry needs to take compliance seriously . . . [because the] culture of compliance . . . takes work. Compliance is important.”)

6. The guidelines use the U.S. Sentencing Commission’s Organization Sentencing Guidelines as a model. Once FERC determines a violation has occurred and a civil monetary penalty is warranted, FERC states its belief that those two factors (seriousness and culpability) reflect the requirements of EPAct 2005, forming the “centerpiece of our penalty regime.” Revised policy statement, PP 3-4, 15-16; see also PP 17-18. The U.S. Sentencing Commission is an independent agency in the U.S. judicial branch created in 1984 to establish federal court sentencing policies and practices, including guidelines on the appropriate form and severity of punishment for offenders convicted of federal crimes. www.ussc.gov.

7. Revised policy statement, PP 171-73, 178, 218; see also Marcoux, “Canaries in the Coal Mine: Facts From Securities Fraud Private Civil Actions Can Identify Intent To Manipulate Energy Markets,” 29 Energy L.J. 141 (2008) (scienter & intent used interchangeably).

8. Revised policy statement, PP 43-50, 56-57, 62-66, 75-79, 88-89, 97.

9. Revised policy statement, PP 63-66.

10. Revised policy statement, PP 75-79.

11. Revised policy statement, PP 122-24, 131-32, 134-35, 160, 162-64, 166, 168, 214.

12. An organization exercising due diligence and promoting a culture to encourage legal compliance can receive a 3 point credit to subtract from its base culpability score. A seven-item, § 1B2.1(b), effective compliance program checklist includes: established standards and procedures; program responsibility appropriate to the governing authority, high-level personnel, and specific individuals; exclusion of individuals engaging in violations from substantial authority personnel; periodic, practical communication of standards and procedures, including training programs; monitoring, auditing, evaluation of effectiveness, and a system to report or seek guidance on actual or potential violations; consistent program promotion and enforcement; and, after detection, steps to respond and prevent further similar violations. A program not meeting in some fashion all items on that checklist can receive partial credit. Revised policy statement, PP 115-19. Credits for other mitigation factors are available on an unbundled basis. Id., at PP 127-29, 140-45, 147-48, 150, 152, 154, 157-58, 191.