On February 2, 2015, Powhatan Energy Fund, LLC, HEEP Fund, Inc., CU Fund Inc., and Houlian (Alan) Chen (jointly Respondents) filed answers to the December 17, 2014, Order to Show Cause and Notice of Proposed Penalty (Order) issued by the Federal Energy Regulatory Commission (FERC). FERC required Respondents to show cause why they should not be found to have violated section 1c.2 of the Commission’s regulations and section 222 of the Federal Power Act (FPA) by engaging in fraudulent Up To Congestion (UTC) transactions in PJM Interconnection L.L.C.’s energy markets. The Order also directed the Respondents show cause why they should not be required to disgorge profits and be assessed civil penalties in the following amounts:

• Powhatan Energy Fund: $16,800,000 civil penalty; $3,465,108 disgorgement

• CU Fund: $10,080,000 civil penalty; $1,080,576 disgorgement

• HEEP Fund: $1,920,000 civil penalty; $173,100 disgorgement

• Chen: $500,000 for trades executed through and on behalf of HEEP Fund and Powhatan and an additional $500,000 for trades executed through and on behalf of CU Fund.

Powhatan replied that Dr. Chen engaged in legal activity that simply exploited a loophole in the rules, and proceeding with these penalties would be unconstitutional because Powhatan did not have prior notice that such trades were unlawful. Dr. Chen, HEEP Fund, and CU Fund similarly responded that the trades were legal and are not in any way akin to wash trades because each trade exposed the trader to loss, FERC has never stated that UTC trades that make or lose money based solely on the interaction of transaction costs and loss credits would be considered market manipulation, and Dr. Chen did not knowingly engage in misconduct. Both answers request that FERC terminate the investigation and dismiss the case. OE Staff will respond by these answers by March 4, 2015.

Neither answer exercised the Respondents’ option to forego litigation before FERC. Specifically, under Section 31(d)(3) of the FPA, the Respondents’ had to option to force FERC to impose civil penalties. If FERC did so, Respondents’ could have refused to pay the penalty for 60 days, at which time FERC would have been required to institute an action in Federal district court. The court would have then reviewed de novo the entire matter and enter a judgment enforcing, modifying, or setting aside the penalty assessment against the Respondents. Other entities, including Barclays Bank, have taken this approach to challenging OE’s conclusions that they engaged in market manipulation. Because the Respondents did not exercise this option, this proceeding will be heard before an Administrative Law Judge at FERC. The ALJ will issue an order that will be reviewed by FERC. If, after hearing and review of the ALJ order, FERC issues an order assessing the penalties, the Respondents may seek judicial review in the appropriate United States court of appeals, which will have the jurisdiction to modify, affirm, or set aside FERC’s order, or remand the proceeding to FERC for further action.

If FERC imposes penalties in this case, FERC will have made clear that conduct that is not expressly prohibited may still constitute market manipulation. FERC has taken an aggressive stance against the Respondents, and has proposed over $30 million in penalties for trades that were not expressly prohibited, and were conducted openly and without any attempt to conceal the actions from PJM or FERC.

It appears that FERC has taken this position because it looks with disfavor upon linked transactions, in which a party enters into one transaction that affects a second transaction. FERC views such transactions as manipulative because they do not have any legitimate business purpose other than to obtain financial benefits as a result of possible loopholes in market rules.