Tuesday, March 26, 2019

PJM Trader Calls FERC on Manipulation Probe

By Ted Caddell and Rich Heidorn Jr.

An energy trading firm that has been the subject of a FERC investigation for more than three years without being charged has decided to go on offense by releasing documents it says proves it has been unfairly hounded.

The dispute provides a case study for critics, including former FERC officials, who say the agency is punishing legitimate, if opportunistic, trading. It may be a topic that comes up when FERC enforcement chief Norman Bay faces a Senate hearing for confirmation as FERC chairman.

Among those on the team challenging FERC are Bay’s predecessor as enforcement chief, Susan J. Court, Harvard professor William Hogan and John N. Estes III, a partner with Skadden Arps and the go-to defense attorney for companies accused of market manipulation. (See sidebar “The Players.”)

$4.7 Million Profit

At the center of the case is Powhatan Energy Fund LLC, a West Chester, Pa., private investment fund headed by portfolio manager Kevin Gates and his identical brother Rich. FERC says Powhatan and a predecessor fund netted $4.7 million in profits in 2010 by taking advantage of a loophole for making low-risk up-to-congestion trades to profit from line loss refunds.

In August 2010, PJM asked FERC to approve Tariff changes to close the loophole (ER10-2280) and the commission notified Powhatan that it was opening up an investigation into the legality of its trading.

Since then, despite a growing file and a preliminary finding that the trades violated FERC market manipulation rules, FERC has not charged Powhatan.

After three and a half years in FERC’s crosshairs, the Gates brothers have had enough.

Website image

Website image

They have built an elaborate website laying out Powhatan’s defense, with copies of its correspondence with investigators and affidavits and video testimonials from a dozen former FERC officials and others supporting their case. FERC could not be reached for comment Monday.

Among those featured are former Court and nine Ph.D.s, including Hogan, former FERC economist David Hunger; consultant Roy Shanker, and two former chief economists for the Securities and Exchange Commission, Chester S. Spatt and Larry Harris.

Gates decided to go public after FERC last week rejected his call to terminate the investigation.

“Powhatan has about ten investors. These individuals have reputations that are important to them. They are concerned that FERC’s accusations will unfairly harm their relationships with family that they love, friends who enrich their lives, and business acquaintances who are vital to their livelihoods,” the company says in an introduction to the website. “…They do not want to carry the stigma of unfounded accusations on their shoulders.”

Trading Strategy

At the heart of the case are a series of trades made by Houlian “Alan” Chen, a Chinese immigrant and Ph.D. engineer hired by Powhatan, who found a way to take advantage of a quirk in PJM’s “marginal loss pricing” method for collecting transmission line-loss payments. The method treats every transmission as if it were the last transmission in the system. Because this method charges each buyer for the most problematic load transmission at the time, it collects far more than actual losses.

The result is “a large pot of money,” as an appellate court described it last year, with “no clear owner.” (See Split Decision for Financial Traders on PJM Line-Loss Collections.)

Chen was among a handful of traders who PJM says netted $19 million in profits by scooping up some of  that money.

Chen determined that if he bought day-ahead energy in Midwest ISO, and sold it at a point in PJM in a UTC trade, and did the same thing in the opposite direction, he could frequently profit.

Although UTCs don’t involved the movement of physical energy, UTC traders then had to reserve transmission service for each transaction, making them eligible for the line-loss refunds. In September 2010 PJM stopped requiring transmission service reservations for UTCs, eliminating the opportunity Chen had exploited.

The change in the PJM Tariff came after FERC notified Powhatan and Chen that it was investigating their trades.

Wash Trades or Not?

Testimony to FERC on behalf of ChenFERC investigators notified Chen and Powhatan that it had opened an investigation on Aug. 18, 2010. Over the next 15 months, Powhatan sat for depositions and responded to three sets of FERC data requests, followed by several months of arguments among attorneys for the company and the commission over whether the company had fully complied with the requests.

In one exchange, Powhatan attorney William M. McSwain got personal with Steven C. Tabackman, the lead FERC attorney in the case.  “From the beginning, you have exhibited a close-minded, heavy-handed attitude that persists to the present,” McSwain wrote. “For example, in the first deposition of Kevin Gates, you literally fell asleep for 15-20 minutes, with your head down and your eyes closed, as you sat across from Mr. Gates while your colleague questioned him. There were multiple witnesses to this conduct.”

By October 2011, McSwain says, FERC officials had told him a decision on whether to charge Powhatan was “imminent.” Yet little more happened until August 2013 — three years after the case was initiated — when Tabackman sent the company a 28-page document in which enforcement staff summarized its “preliminary findings” concluding that the trades were designed “to manipulate the PJM market to capture and maximize receipt of Marginal Loss Surplus Allocation (MLSA).”

“Chen … designed and scheduled matched UTC transactions that had the same or nearly the same effect as what the law would label a `wash trade’ or `sham’ transaction,” Tabackman wrote. “These trades were carefully configured to eliminate or reduce both profits and losses from price differentials in the market, and they also incurred certain costs related to scheduling the transactions. Yet, these same transactions profited, intentionally so, from collection of the MLSA based on associated transmission reservations.”

Powhatan Response

Chen’s attorney, John N. Estes III, wrote an eight-page response. “The trading activity at issue was consistent with price signals approved by the Commission, added value to the PJM markets and assumed market risks, and contained absolutely no deceptive or fraudulent element,” he wrote.

McSwain’s response was only two sentences: “Your preliminary findings make no sense. Should you choose to proceed with a public notice against Powhatan and/or Huntrise [a predecessor fund operated by the Gates brothers], please be advised that they will respond publicly and forcefully.”


While the Gates brothers and Chen are fighting the FERC investigation, one company that engaged in similar trades, Oceanside Power LLC, agreed a year ago to settle the charges against it by disgorging profits of $29,563 and paying a fine of $51,000 (IN10-5).

Leave a Comment