May 6, 2008

Market Manipulation in the Petroleum Industry Federal Trade Commission Seeks Public Comment On Anti-Manipulation Rule in the Petroleum Industry SUMMARY The Federal Trade Commission (“FTC”) has issued an Advance Notice of Public Rulemaking (“Notice”) announcing to the public that it is considering prescribing a new rule banning market manipulation in the petroleum industry.1 The FTC would promulgate the new rule pursuant to Section 811 of the Energy Independence and Security Act of 2007 (“EISA”), which proscribes manipulative and deceptive practices in the petroleum industry and authorizes the FTC to promulgate specific implementing rules. The FTC has provided for a 30-day period, expiring June 6, 2008, in which the public may comment about whether the FTC should proceed with prescribing a new rule and how such a rule should be drafted.

BACKGROUND Section 811 of the EISA, which became effective December 19, 2007, declared it is unlawful for anyone, in connection with the wholesale purchase or sale of crude oil, gasoline, or petroleum distillates, to use any “manipulative or deceptive device or contrivance, in contravention of such rules and regulations as the Federal Trade Commission may prescribe as necessary or appropriate in the public interest or for the protection of United States citizens.”2 Section 811 generally proscribed manipulative or deceptive practices in the petroleum industry and granted the FTC the right to promulgate specific rules and regulations banning such conduct. Section 811 provides the FTC with a variety of enforcement mechanisms, including (a) filing a civil action in federal district court seeking a temporary restraining order or preliminary injunction to prevent future violations, (b) seeking to freeze or seize any assets obtained via a violation of this section, and (c)

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seeking to recover civil penalties of up to $11,000 per violation, or, with respect to suppliers, penalties of up to $1 million per day. On May 1, 2008, the FTC announced its issuance of a Notice to (i) formally announce the FTC’s intent to consider prescribing a new rule pursuant to Section 811 and (ii) provide the public with an opportunity to submit comments about whether it is a good idea for the FTC to prescribe such a rule and, if so, how such a rule should be written. The Notice establishes a 30-day public comment period, which expires June 6, 2008. The Notice is the first step in the formal rulemaking process. After expiration of the comment period, the FTC will analyze the comments received, draft a proposed rule, and issue a second notice (a “Notice of Proposed Rulemaking”) that will be subject to an additional 30-day public comment period. The FTC states that it will use the feedback that it receives during both 30 day-public comment periods in deciding if and how to develop a new rule. The FTC’s stated goal is to complete the rulemaking process by the end of this year.

REQUEST FOR FEEDBACK Relevant Framework The Notice provides the public with background information about Section 811 that will be useful for commentators to consider in crafting comments about a potential new rule. Of particular interest: •

The Notice advises that Section 811’s language – forbidding the use of any “manipulative or deceptive device or contrivance” in connection with the wholesale purchase or sale of petroleum and authorizing the FTC to prescribe rules enforcing the section – is derived from Section 10(b) of the Securities Exchange Act (“Exchange Act”). The Notice indicates that, pursuant to the authority granted to the SEC by Section 10(b), the SEC prescribed Rule 10b5, which prohibits fraudulent conduct in connection with the purchase or sale of securities, and which the SEC frequently relies upon in pursuing anti-fraud actions.

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The Notice advises that the Energy Policy Act of 2005 contains similar language banning “any manipulative or deceptive device or contrivance” and authorizing the Federal Energy Regulatory Commission (“FERC”) to prescribe rules prohibiting natural gas market manipulation and electric energy market manipulation, which the FERC has proceeded to do relying upon Exchange Act Section 10(b) and Rule 10b-5.3

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The Notice observes that the Commodities Future Trading Commission (“CFTC”) has been authorized by the Commodity Exchange Act (“CEA”) to bring an action against anyone who has unlawfully “manipulated or attempted to manipulate the market price of any commodity.”

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The Notice indicates that the FTC generally has had authority under the federal anti-trust laws to enforce prohibitions against monopolizations and other unfair methods of competition, and that practices potentially relating to market manipulation could also fall within the ambit of these laws.

After reviewing these statutory and regulatory precedents and exploring case law interpreting these various provisions, the Notice encourages commentators to assess whether the FTC should develop a rule incorporating aspects of already-existing anti-fraud and anti-manipulation provisions. -2Market Manipulation in the Petroleum Industry May 6, 2008

Questions The Notice contains specific questions and issues that it asks the public to consider. These questions and issues include the following: •

Definition of Market Manipulation – The Notice offers the following as a possible definition of “market manipulation” under Section 811: Knowingly using or employing, directly or indirectly, a manipulative or deceptive device or contrivance – in connection with the purchase or sale of crude oil, gasoline, or petroleum distillates at wholesale – for the purpose or with the effect of increasing market price thereof relative to costs. The FTC seeks feedback about this definition, including “whether an effect on prices should be a necessary element of proof under either a charge of market manipulation or a charge of attempted market manipulation.”4 The Notice also seeks comment about whether this proposed definition is one pursuant to which a rule could be prescribed that would be “necessary and appropriate in the public interest or for the protection of United States citizens” (as Section 811 requires). Lastly, the Notice invites commentators to suggest other definitions of “market manipulation” for the purpose of developing a rule under Section 811.

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Impact of Other Agencies’ Rules – The Notice asks commentators to consider the extent to which the FTC’s exercise of its rulemaking authority under Section 811 should depend upon how other federal agencies, such as the SEC and FERC, have exercised similarly granted authority under the Exchange Act and the Energy Policy Act, respectively. The Notice asks commentators whether they believe that judicial interpretations of anti-fraud and antimanipulations regulations developed by the SEC and FERC will be applied by courts to an anti-manipulation rule passed by the FTC. The Notice encourages commentators to “identify both general criteria and specific applications of the other laws, and to explain why each should or should not apply under a Section 811 rule, with a specific discussion of the costs and benefits of application.”5 In addition, the Notice asks commentators to consider the potential costs and benefits of the FTC promulgating a rule that would mirror the language of the anti-fraud and anti-manipulation provisions prescribed by the SEC or FERC.

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Effect on the Market – The Notice asks commentators the degree to which a new rule should focus on distortions caused in the market by any deceptive or manipulative conduct.

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Scienter/State of Mind – The Notice seeks comments on whether an actor should need to have a specific intent to cause harm to the market (or some other culpable state of mind) in order to be found guilty of violating a new rule. The Notice asks for public feedback as to whether a new rule should explicitly incorporate a certain state of mind standard, and whether the nature and level of that standard should depend on the particular practice in which an actor is engaged.

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Statutory Interpretation – Section 811 requires that any unlawful manipulative conduct under the section be conduct that is used or employed “in connection with the purchase or sale of crude oil gasoline or petroleum distillates at wholesale.” The FTC seeks guidance regarding how this phrase – and in particular how the terminology “in connection with” – should be interpreted. Section 811 also requires that any rule passed by the FTC be “necessary or appropriate in the public interest or for the protection of United States citizens.” The FTC asks for guidance concerning how to interpret this clause, and how to ensure that a new rule would meet this standard.

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Penalties – The Notice seeks feedback about potential penalties that could be assessed if a new rule were to be transgressed. The Notice observes that Section 814 of the EISA provides a civil penalty of up to $1 million per day against suppliers for a rule violation, and invites comment about whether “any potential chilling effects of these penalties on legitimate -3-

Market Manipulation in the Petroleum Industry May 6, 2008

business behavior should affect the interpretation of, or required mind state for, a manipulative device or contrivance.”6 •

Jurisdictional Overlap – The Notice asks whether there might be a jurisdictional overlap between the FTC and other federal agencies, which could cause problems such as subjecting market participants to inconsistent standards, and creating multiple levels of liability.

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Examples of Potentially Manipulative Behavior – The Notice describes certain potential practices in which market participants may engage, and asks whether commentators think that these particular practices should be treated as manipulative or deceptive under Section 811. For instance, the Notice observes that regulated petroleum pipelines may have rules preventing new shippers from using the pipeline when the pipeline is at overcapacity due to the activities of historical shippers. The Notice then asks whether pre-announcements that pipelines are coming close to their capacity constraints may be a “conduit” for market manipulation or deceit under Section 811, and whether the benefits of applying Section 811 to this behavior would outweigh the costs. Additionally, the Notice observes that some have argued that “market participants with terminal or other storage inventory should be under an affirmative obligation to release inventory during price spikes when the participant knows, or should know, that the release of the product will be profitable.”7 The Notice asks for comments about whether this affirmative obligation to release inventory should be imposed and, if so, what should be the parameters of this obligation. Moreover, the Notice observes that “accurate cost and volume data for wholesale transactions at all levels of trade, refinery, or pipeline outage data, and import and inventory volumes are frequently difficult to construct or are unavailable.”8 The Notice asks whether the FTC can – and should – promulgate a rule instituting a requirement to report this information.

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Case Studies – The Notice concludes by presenting two case studies involving BP Amoco/Atlantic Richfield and Enron, and asks commentators to provide feedback on a series of questions relating to these case studies. *

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ENDNOTES 1

Prohibitions On Market Manipulation and False Information in Subtitle B of Title VIII of The Energy Independence and Security Act of 2007: Advance Notice of Proposed Rulemaking and Request for Public Comment (hereinafter “Notice”), 16 CFR Part 317.

2

Energy Independence and Security Act of 2007 § 811, 42 U.S.C. § 17301 (2007).

3

See generally Memorandum from Sullivan & Cromwell LLP on Regulatory Enforcement (Dec. 19, 2007).

4

Notice at 23.

5

Notice at 24.

6

Notice at 28.

7

Notice at 31.

8

Notice at 32.

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