actimize energy trading compliance research 2010

8/8/2019 Actimize Energy Trading Compliance Research 2010

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Energy Trading ComplianceAn independent study initiated by NICE Actimize and Fulbright & Jaworski L.L.P.

September 2010

This document contains proprietary information belonging to Actimize, Inc. and Fulbright & Jaworski L.L.P. Nopart of its contents may be used for any purpose, disclosed to any person or firm or reproduced by any means,

electronic or mechanical, without the express prior written permission of both Actimize, Inc. and Fulbright &Jaworski L.L.P. For more information, contact Actimize at [email protected] or Fulbright & Jaworski

at [email protected]


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Energy Trading Compliance

2

An independent study initiated by NICE Actimize and Fulbright & Jaworski L.L.P. September 2010

Executive Summary

In mid 2010, NICE Actimize and Fulbright & Jaworski L.L.P. commissioned astudy of senior executives and compliance personnel in the energy tradingsector. The purpose of the study, conducted by an independent research firm,

was to capture the state of compliance within the energy trading industry, and togauge the industrys overall readiness to deal with increasingly stringentregulations and greater government enforcement capabilities.

More than 140 industry participants responded to the questionnaire. Of those,more than one in six self-identified as senior management, with 80 percentholding positions on the front lines of compliance, including: trading, riskmanagement, legal, and senior management.

The study was designed to collect data concerning a number of core energytrading compliance issues, including: (i) how respondents perceive theknowledge sets, skill sets, challenges, and motivations forand barriers toaddressing compliance concerns at their respective organizations; (ii) howrespondents view those same issues for the industry as a whole; and (iii) howrespondents see the knowledge sets, skill sets, and resources of the regulatorsevolving.

While the research was in process, the Dodd-Frank Wall Street Reform andConsumer Protection Act became law. As the industry looks toward 2011, theresulting regulatory changes brought about by the Dodd-Frank Act will affectevery aspect of the energy trading industry as the Commodity Futures TradingCommission (CFTC), the Securities and Exchange Commission (SEC), and the

Federal Energy Regulatory Commission (FERC), among others, implement newrules and regulations for industry compliance.

The research results illustrate that compliance prior to the Dodd-Frank Actrequired a sophisticated knowledge of multiple complex regulations and thededication of substantial resources within a well designed compliance program.Passage of this new legislation now adds an additional layer of challenge forthose in the industry.

The research portrays an energy trading industry that is: (i) in an early stagecompliance program adoption process; (ii) fragmented in its approach; (iii)unclear as to best practices; (iv) still facing decisions as to when to make majorinvestments in training, systems or resources; and (v) coming to terms with the factthat corporate culture must be reshaped for compliance to be achieved. Whilethe study identified areas where industry responses were remarkably consistent,especially as to the near- and mid-term regulatory landscape, the study identifiedother areas where responses displayed significant divergence -- such as what isbeing done to develop compliance infrastructure to adapt to the emergingregulatory landscape.


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Increasing Need for Compliance Solutions

The need for proactive compliance programs, including formal training, the distribution of compliance documents, and real-time surveillance, is increasing.

Research results indicate that many in the energy trading industry recognize that regulators are increasing their enforcementactivity, resources, and infrastructure. Approximately 80 percent of respondents believe regulatory audit and enforcementactions against energy trading firms will increase. In addition, almost 40 percent of respondents believe regulators alreadyhave the capability to examine energy trading activity, while others believe regulators will ramp up surveillance capabilities inthe near future. These results suggest that regulators will be better, and faster, at discovering suspected illegal behavior in theenergy markets, and that queries to companies may increase. Accordingly, improved compliance programs and infrastructure,including the use of automated surveillance, is seen as a significant industry need.

Market participants that stand still and only use data mining or other techniques to audit past performance may miss the markset by the practices of industry leaders and regulators' expectations. Companies that only employ data mining to discoversuspect activity may need to play catch up when approached by regulators, which could impact how they are treated byregulators when transgressions occur.

Risk vs. Compliance Oversight

There is significant divergence within the energy sector on where energy trading compliance is managed. There is alsodivergence on the quality of information distributed to enable compliance with energy market trading regulations.

Approximately 30 percent of respondents indicated that energy market compliance was managed by the organizations riskmanagement group, approximately 23 percent indicated that compliance was managed by the legal department, while otherrespondents indicated that compliance was managed by either an independent compliance group (18 percent) or a businessunit (12 percent). In addition, almost 30 percent of respondents indicated that their organization did not have a centralizedcompliance function or that they did not know whether a centralized compliance function existed. Approximately 1 in 5respondents also reported that their organization did not adequately disseminate the information needed to achievecompliance. These study results suggest that creating a single structure for management and analysis of data for compliancepurposes is something of value that the industry has not fully addressed.

The research indicates that the energy sector has not yet adopted a generally accepted best practice rubric for energytrading compliance. In many ways, the research suggests that the energy industry views compliance as it did risk managementin the mid-90s industry participants are unclear how to value the compliance investment and how to best implementcomprehensive compliance programs, but they are fairly sure action is needed.

The research participants demonstrate an understanding of the consequences for adopting inadequate energy tradingcompliance measures. More than 60 percent of respondents believe civil or criminal fines are one of the three greatest risksto energy trading firms and executives if they fail to establish an effective compliance program, while more than 50 percent ofrespondents also believe reputational risks are among the top three hazards for compliance inadequacies. These resultsindicate that many energy market participants recognize that the failure to be proactive with regard to compliance can leadto substantial financial losses and sullied corporateor personalreputations.


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4


Acknowledgement of Rules and Compliance Readiness

There is evidence of an apparent gap between how respondents perceive their own compliance capabilities versus thoseof the industry as a whole. Many respondents seem to believe their own organizations are in a better position to complywith energy market trading regulations than others in the industry. For some, this confidence may be misplaced.

More than 60 percent of respondents believe their organization has a good or excellent understanding of compliance rules.However, less than 13 percent of respondents rate the energy trading industrys readiness to comply with new energy tradingregulations as good or excellent. In addition, more than 40 percent of respondents report utilizing a manual compliancereporting system, and just over one third of respondents report utilizing a system to automatically examine for suspicious activityon a daily basis. Approximately 10 percent of respondents indicate that their firms never audit the effectiveness of theircompliance functions, while only approximately 27 percent of respondents report conducting quarterly or monthly complianceprogram evaluations. As for resources, more than 25 percent of respondents believe their organizations are not devotingsufficient staff and resources to compliance.

The study results indicate that while the majority of energy trading companies may have a basic knowledge of the applicablerules and regulations, many companies may not systematically review their trading activities for compliance with those rules,and some not devote adequate resources to compliance. The results also suggest that while there is a clear need to keep upwith changing energy market rules, it is also critical for energy trading firms to focus on strong compliance programdevelopment, implementation, and maintenance.

Regulators Reach Across All Markets

R

espondents indicated they are as concerned about physical and Over-the-Counter (OTC) market compliance as theyare about futures market compliance. Approximately 83 percent of respondents indicated that OTC transactions and/orphysical transactions are as much or more of a compliance concern than exchange transactions. This result suggests a

shift in energy market compliance from a primary focus on regulated exchange trading to a broader focus on all transactiontypes. Energy market participants are now also dealing with a range of regulatory agencies, often with overlappingjurisdiction.

The concern of industry respondents regarding OTC and physical transactions suggests that formal compliance policies andsystems are likely to become of greater importance for all energy market participants, especially in light of the newrequirements imposed by the passage of the Dodd-Frank Act and the consideration of potential new financial regulationsacross the globe.


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Regulatory Pressure Will Increase

Not one industry participant indicated that regulatory pressures for compliance would diminish in the future, and allapplicable responses indicated that regulators would strengthen their ability to detect suspicious behavior. Further, norespondent expected investment by regulators in systems or staff to decrease. However, approximately 80 percent of

respondents indicated that they expected the number of audits and enforcement actions taken against energy trading firms toincrease. These results point to a regulatory structure that is in flux and one that may become increasingly burdensome forenergy market participants.

Respondent Profile and Research Background

NICE Actimize, a leading provider of technology solutions for brokerage compliance, anti-money laundering and fraudprevention, and Fulbright & Jaworski, L.L.P, a premier law firm with a diversified practice serving the needs of the globalenergy industry, sponsored this research study. Infosurv, an independent research firm, conducted the project in the

second quarter of 2010.

The research participants included 142 executives and employees of energy trading industry stakeholder enterprises from

across the globe. The study was completed online via a questionnaire that consisted of more than 34 questions.1

Of the 142 energy industry participants, nearly four out of five serve in commercial (trading/origination), oversight (risk orcompliance), or executive roles. The demographics indicate that the majority of respondents are on the front line of tradingoperations and compliance, or are key decision makers for compliance issues.

The respondents represent trading firms globally, with a majority having trading interests in North American markets.Participants also represent firms with business interests spread across all developed continents and regions, particularly in theUnited Kingdom, Western Europe, and Asia. The regional activity and portfolio asset size of the firms are broadlyrepresentative of the overall energy trading market.

1 Additionally, three regulators completed a parallel questionnaire consisting of 18 questions. Due to the limited number of responses, those

results have not been included in this report.


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Which markets cause the greatest compliance concern for you and your organization?(Respondents could only choose a single response)

83 percent of respondents indicate that swaps and physical transactions are as much or more of a compliance issue thanexchange traded instruments. Products and programs that deal solely with exchange futures fail to address a major gapin energy trading compliance.

Do you believe your current organization's control systems will be able to manage compliancereporting adequately on a daily and potentially intra-day basis?(Respondents could only choose a single response)

Increasing Need for Compliance

Fewer than half of the respondents believe their systems are capable of managing compliance on a daily andintra-day basis.

Many regulators run analysis in 10-minute delays, which could result in regulators uncovering a potential problem prior tothe firm knowing about it. Slow monitoring and reporting increase the risk and size of fines, as well as the possibility ofbeing excluded from trading in certain markets.

Energy trading firms must establish strong compliance training and policies that empower and encourage officers, and keepemployees within regulatory boundaries. Firms should also implement systems that can expeditiously identify suspiciousbehavior related to trading.

Physical transactions

Exchange transactions

Over-the-counter transactions

All of the above, equally

Don't know

0 5 10 15 20 25 30 35 40

24.6%

9.2%

23.2%

35.2%

7.7%

Yes

No

Dont know

46.7%27.7%

25.5%


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What is your estimate of the number of compliance employees within your organization?(Respondents were limited to brief text responses)

More than 50 percent of respondents work for trading firms with six employees or less who oversee and manage

compliance. If firms with the fewest number of compliance employees are also trading on the smallest annual wholesaleenergy transaction portfolio, the 50+ percent of firms with six or less compliance employees may have books of up to$999.9 million. Firms in these situations must weigh whether having a compliance staff of this size can keep up with thechanging face of regulation on multiple fronts, as well as the overselling of all trading activity.

The fact that more than one-fifth of the respondents report that their firms have less than fully acceptable dissemination ofinformation necessary to achieve compliance may also support a conclusion that existing compliance staffs areoverburdened. It may be appropriate to outsource one-time, infrequent, or highly specialized compliance related tasks.

4.4

%

7.4

%

10.3

%

7.4

%

5.1

%

13.2%

3.7

%

2.2

%

2.2

%

8.8

%

2.2

%

2.9

%

5.9

%

4.4

%

1.5

%

2.9

%

2.2

%

5.9

%

7.4

%

0

3

6

9

12

15

0 1 2 3 4 5 6 7 8 10 12 15 20 25 30 40 50 100+ OtherResponses


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How often does your organization audit the effectiveness of its compliance program?(Respondents could only choose a single response)

Risk vs. Compliance Oversight

10 percent of those responding indicate that their firms never evaluate their compliance program, and nearly a third ofthe remaining respondents indicate that their compliance programs are evaluated only once per year.

Responses indicate that a significant number of energy trading firms may be unable to discover issues in time to self-report quickly enough to receive leniency from regulators.

Regulators tend to discount the self-reporting that occurs on the eve of a required disclosure that would likely give rise tothe discovery of the violation, or one that comes after undue delay. Thus, examining compliance in connection with

other annual reporting functions may do little to convince a regulator to treat a self-report as a mitigating factor in thewake of a compliance violation.

It appears that many firms are taking large risks with respect to racking up substantial multi-day, multiple-instanceviolations that are subject to penalties on a per day/per instance basis.

0 5 10 15 20 25 30 35

Weekly

Monthly

Quarterly

Annually

Never

Don't know

Other

0.8%

7.8%

19.4%

32.6%

10.1%

24.8%

4.7%


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In your organization, to whom does the compliance function report?(Respondents could only choose a single response)

What communication formats does your firm currently monitor for compliance purposes?(Respondents were allowed to choose multiple responses)

Responses suggest there are gaps in the defenses. While two-thirds of respondents indicate that their organizations monitore-mail, fewer than one in 10 monitors texting. About 40 percent monitor instant messaging, which means that up to 60percent may not.

According to one industry expert, up to 60 percent of trading in the physical power markets is done via instant messaging.

Nearly one quarter of respondents did not know what forms of communication were monitored at their firms.

0 5 10 15 20 25 30

CEO

General Counsel

Compliance Committee

Board of Directors

Don't know

Other

20.2%

25.6%

10.9%

9.3%

17.1%

17.1%

0 10 20 30 40 50 60 70 80

Company telephone

Personal and company cell phone

Electronic mail

Instant messages

Texting

Don't know

Other

54.3%

15.5%

65.9%

40.3%

7.8%

22.5%

5.4%


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10


Who manages your energy market compliance?(Respondents could only choose a single response)

While the industry has not seized upon a single approach for delegating responsibility for oversight and managingcompliance, the factors that must be taken into account in determining how the compliance function should be structured are

common to all stakeholders. For example, if the organization does not have in-house counsel, does relying on the sameoutside counsel that assists that organization with the terms of its deals (1) make sense because the outside lawyers havethe best understanding of the organizations business, or (2) create a thorny conflict of interest, whereby the outside counselis encouraged to take compliance risks in order to avoid impediments to generating more deals and more business for itself?

If the organization has in-house counsel that is also responsible for compliance, similar concerns are raised with the furtherdifficulty that in-house General Counsel that are called upon to judge their own actions may be in a position to kill anyunbiased self-examination. Even where in-house counsel is not ostensibly responsible for managing compliance, the GeneralCounsel may be so involved with management of the business that it is difficult for the organization to evaluate complianceissues realistically.

Placing the risk management group in charge of compliance can have the advantage of allowing compliance managersaccess to a broad range of real-time data that can otherwise be difficult to obtain even within a single organization.

However, it also requires that the group be able to put a different perspective on compliance than the other risks that suchgroups are traditionally called upon to analyze.

Traditional risk management involves balancing the economic pros and cons of different but equally permissible choices thatcan largely be reduced to dollars and cents, where hedges can be used to balance risk and reserves can be created toensure against irreducible downside risk. In contrast, compliance generally involves choosing between an acceptable, buteconomically less appealing behavior, and impermissible behaviors that tantalize with higher short-term returns, where thedownsides cannot be hedged or accounted for with reserves. Thus, the management of these two functions requires verydifferent skill sets.

Finally, placing compliance in its own group creates issues with respect to information access and authority. Can anorganization that gives free access or pushes all relevant information to a compliance group, and imbues that group withauthority to investigate suspicious activity, veto actions, and impose internal disciplinary sanctions, be counted on to makerealistic choices and avoid undue interference while conducting business on a day-to-day basis? Any efforts to place limitson information available to, or circumscribe the scope of, the authority of a separate compliance may render it impotent,either in practice or simply in the eyes of governmental authorities charged with determining whether the organizationscompliance efforts were sufficient to warrant leniency when a transgression occurs. These issues demand attention from thetop with appropriate counseling.

0 5 10 15 20 25 30

Risk management

Legal

Independent compliance group

Business Unit

Don't know

Other

29.9%

23.4%

18.2%

12.4%

3.6%

12.4%


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Do you believe your organization's current compliance and control systems will be able to handlerequirements imposed by any new energy market position limits rules and regulations?(Respondents could only choose a single response)

How frequently does your organizations oversight system automatically examine forsuspicious activity?(Respondents could only choose a single response)

The new position limit monitoring obligations as clarified in the CFTC Division of Market Oversight Advisory published in May2010 requires firms to monitor positions on a daily basis, as well as on an intraday basis in some circumstances. This appliesto both Federal limits as set forth in regulation 150.2 as well as limits set by exchanges. In other words, a trader whoseposition exceeds the applicable speculative position limitat any time during the day is in violation of the Commodity ExchangeAct and CFTC regulations, even if the position is subsequently reduced to a level within the applicable limit by the close ofthe market for that day2.

Nearly two-thirds of respondents felt that their internal compliance and control systems were capable of meeting new positionlimit requirements; yet only three percent indicated that their oversight systems are capable of intraday monitoring, and justover 40 percent indicated their firm is monitoring on a daily basis.

This data seems to indicate a disconnect between how the industry views their monitoring capabilities and the requirementsof such monitoring by current and proposed regulations. The fact that just over 40 percent of respondents indicated their firms

are monitoring on a daily basis may be indicative of the learning curve and investment in monitoring capabilities that energytrading firms must now face.

2 Advisory Regarding Compliance with Speculative Position Limits. U.S. Commodity Futures Trading Commission, Division of MarketOversight. May 7, 2010

http://www.cftc.gov/ucm/groups/public/@industryoversight/documents/file/specpositionlimitsadvisory0510.pdf

Yes

No

Dont know

62.8%

26.3%

10.9%

0 5 10 15 20 25 30 35 40

Intra-day

Daily

Weekly

Monthly

Quarterly

Don't know

Other

3.4%

39.0%

1.7%

2.5%

5.9%

39.0%

8.5%


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12


How effective is your organization at internally disseminating the information needed to comply withenergy market trading rules and regulations?(Respondents could only choose a single response)

About 1 in 5 respondents report that their organization is not adequately disseminating the information needed to achievecompliance.

To achieve an adequate distribution of compliance related information, firms may need to consider hiring additionalcompliance staff, outsourcing compliance related tasks, or investing in technology that will enable them to efficientlydisseminate, track, and audit information more effectively.

Does your firm have one centralized person or group responsible for compliance?(Respondents could only choose a single response)

Yes

No

Dont know70.6%

7.4%

22.1%

0 5 10 15 20 25 30 35

Poor

Somewhat acceptable

Acceptable

Good

Excellent

Don't know

7.8%

13.2%

30.2%

33.3%

10.1%

5.4%

70 percent of respondents indicated that they have a centralized compliance function. A centralized compliance functionprovides a holistic view of compliance and regulatory issues across the enterprise and provides clear lines of responsibilityand accountability as the compliance program matures. This is an important step in the evolution of compliance within the

trading industry, and is the foundation upon which many other tenets of an effective system of supervision can be built.


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What generation of technology is your organization using to monitor for energy trading compliance?(Respondents were allowed to choose multiple responses)

A majority of the respondents indicated that they are currently utilizing some form of manual monitoring for energy tradingcompliance. This further highlights the disconnect between the industrys investment in compliance infrastructure and theircurrent and future monitoring obligations. In a manual environment, it is nearly impossible to detect issues like marketmanipulation, violations of position limits, and other issues mandated by regulators.

Automated compliance systems bring efficiencies to the monitoring process and enable analysts to move from spending theirtime mining data for potential violations to spending more of their time proactively responding to exceptions.

The efficiencies and cost reduction afforded by automated monitoring systems and processes will become more compellingto the industry as they seek to mitigate increasing regulatory, reputational, and litigation risks that are so prevalent in thecurrent environment.

Do you believe your organization is devoting sufficient staff and resources to compliance?(Respondents could only choose a single response)

Yes

No

Dont know

55.1%25.4%

19.5%

Manual - reviewing paper logs or conducting spreadsheet analysisFirst Generation - running IT managed queries against databases, manually looking overresults for suspicious behavior

Second Generation - tools in place to automate queries and deliver reports in electronicformat via email or portal, reports still reviewed manually

Third Generation - single platform and workflow tools automatically execute analytics anddata mining to detect defined and unknown patterns across many databases and applications

43.4%

41.1%

34.9%

8.5%

Manual

First Generation

Second Generation

Third Generation

0 10 20 30 40 50


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When is the trading and risk staff required to complete compliance training?(Respondents were allowed to choose multiple responses)

A substantial portion of the industry appears to be devoting inadequate resources to training. Slightly more than one in four

respondents work for firms that provided compliance training prior to them assuming their duties. Less than one-third receives

training on an as needed basis.

Energy trading company employees should be trained prior to assuming duties, even if they have been recruited from another

energy trading company and received training there.

Supplemental compliance training should be provided as needed, including when new requirements are imposed or a new

understanding of existing requirements arises. In addition, periodic refresher courses (e.g., annual refresher training) should

be completed on a regular basis.

0 10 20 30 40 50

Prior to assuming duties

Monthly

Quarterly

Annually

As needed

Voluntary training only

Don't know

Other

27.1%

1.7%

8.5%

46.6%

30.5%

2.5%

13.6%

3.4%


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16


What do you believe are the greatest risks to executives or firms if they fail to establish an effectivecompliance program?

(Respondents were allowed to choose up to three responses)

Almost two-thirds of respondents believe criminal and civil liabilities to senior executives are one of the top three risks of acompliance failure.

Nearly one-half of respondents do not believe that the reputation of the firm or its executives was a key risk, and more thanone-half do not identify monetary loss as a key risk. Nearly three-quarters do not find personal liability or incarceration akey risk.

Many in the industry may not understand that they could be held personally responsible in a corporatecompliance failure.

0 10 20 30 40 50 60 70 80

Monetary

Seizure of assets

Restricted trading activity

Civil or criminal fines

Operational disruption

Effect on morale or productivity

Personal liability/incarceration

Reputational

Don't know

Other

40.7%

6.8%

27.1%

61.9%

29.7%

8.5%

26.3%

54.2%

2.5%

1.7%


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How strong is your organization's understanding of all the energy market trading rules and regulationsit must comply with?(Respondents could only choose a single response)

Acknowledgement of Rules/Compliance Readiness

Four-fifths of the respondents report that their organizations have at least an acceptable understanding of the rules that apply to them.However, more than one in 10 rate their organization's knowledge as less than acceptable, and more than one in 20 do not know.

Enforcement agencies can expect to be busy. Disruptions will occur in the rest of the industry where more than ten percent ofrespondents indicate that their organizations do not know the trading rules and regulations.

According to the Federal Energy Regulatory Commissions Strategic Plan for 2009-2014, FERC expects to find, through audits andinvestigations performed in 2010, that just 10 percent of company compliance programs demonstrate a culture of compliance, and thatjust 10 percent of investigations that lead to penalties will involve companies with compliance programs that merit granting leniency. FERCexpects both of these percentages to improve by a factor of 2.5x by 2011, and increase to 70 percent by fiscal year 2014. 3

Clearly, energy trading enterprises that do not take steps soon to develop compliance programs that include a culture ofcompliance and proactive monitoring of their own compliance could expect very little leniency in the future should a lapse intheir compliance be discovered.

In U.S. dollars, what is your estimate of the industry-wide total energy market fines and penaltiesover the last three years?(Respondents could only choose a single response)

Almost three-quarters of the respondents lack a strong understanding of the value of fines and penalties assessed on the industry within the lastthree years. More than 40 percent of respondents either grossly underestimated the level of fines and penalties levied, or simply didnt know.

Can organizations develop reasonable compliance budgets without fully grasping the stakes? For example, total energymarket fines and civil penalties, including settlements, imposed by FERC over the last three years exceeded $119 million. Duringa longer period, from December 2001 through September 2009, the total civil penalties imposed by the CFTC in energy marketenforcement actions exceeded $450 million.

0 5 10 15 20 25 30 35

Poor

Somewhat acceptable

Acceptable

Good

Excellent

Don't know

2.8%

9.9%

20.4%

32.4%

28.9%

5.6%

0 5 10 15 20 25 30

Less than $50 million

$50-$99.9 million

$100-$499 million

$500-$999 million

Over $1 billion

Don't know

17.6%

12.7%

26.1%

10.6%

9.9%

23.2%


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19/2819

Select the top three criteria you believe regulators evaluate when determining the magnitude of acompliance failure and subsequent fines or penalties?(Respondents were allowed to choose multiple responses)

Regulators Reach Across All Markets

Close to one in five respondents believes that one of the top three considerations in the severity of a compliance sanctionby a regulator will reflect the quality of the corporate compliance surveillance in place. Nearly one in four believes thatone of the top three considerations in the severity of a compliance sanction by a regulator will be whether the companyself-reported the violation.

Due to the fact that 80 percent of respondents believe that regulatory audit and enforcement actions will increase, theexistence and use of surveillance is seen as a necessity as regulators increase scrutiny in the coming years.

A small but significant number of respondents identify several factors among the top three criteria that are not included inpending FERC Penalty Guidelines. While FERC has chosen to evaluate public comments and possibly fine-tune the Penalty

Guidelines before implementing them, these rules best illustrate FERCs current position regarding penalties.

Clearly, there exists a less than universal understanding of the factors that influence FERCs determination of penalties. Inorder to devise cost-effective compliance programs and encourage management, and employees, to avoid unnecessarybehaviors that could compound the seriousness of violations, energy trading firms need to develop a better understandingof the mechanics of compliance enforcement.

Number of employees at the non-compliant organization

Annual revenues of the non-compliant organization

Profitability of the non-compliant organization

Number of years the non-compliant organization has done business in the markets related tothe violation

Whether the violation involved fraud, manipulation or anti-competitive conductWhether misrepresentations and false statements to regulators were involved

Whether there was a violation of the basic tenets of fairness or moral turpitude was involved

The magnitude of the loss suffered by third-parties as a result of the violationSenior management of the non-compliant organization was involved in the violation

Prior violations committed by the non-compliant organization that occurred more than fiveyears in the past

The violator had in existence an otherwise effective compliance and ethics program at the timeof the violation

The non-compliant organization has a document retention policy that resulted in thedestruction of relevant documents prior to the discovery of the non-compliant activity

The non-compliant organization self-reported the violation to the applicable regulatory agency

2.8%

11.3%

11.3%

6.3%

75.4%62.0%

8.5%

35.2%24.6%

12.7%

19.7%

7.0%

23.2%


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20


Do you believe it is likely that regulators will implement capabilities to directly examine yourcompany's activities?(Respondents could only choose a single response)

Regulatory Pressure Will Increase

More than 50 percent of respondents indicate regulators have, or soon will have, the ability to directly monitor energytrading compliance. Of that group, more than 80 percent believe that regulators might already have this ability. Delayinguntil regulators can find the violation is no longer a prudent option.

FERC has a dedicated Office of Enforcement (OoE), charged with the timely identification and remediation of marketproblems, ensuring compliance with Commission rules and regulations, and detecting and crafting remedies to addressmarket manipulation and other noncompliance issues. Three divisions within the OoE are devoted to compliance-relatedfunctions, including the Division of Energy Market Oversight (DEMO), the Division of Audits, and the Division ofInvestigations.

DEMO oversees the US natural gas and electric power markets and related energy and financial markets. DEMOconducts daily oversight of these markets and reports its findings and recommendations to the Commission. DEMOmaintains proprietary databases culling trading and other market information from energy exchanges, private dataaggregators and venders, and other government entities.

The OoE also staffs an Enforcement Hotline, which accepts tips from trading company employees, trading partners, andothers with respect to failures to comply with matters subject to FERCs jurisdiction.

0 5 10 15 20 25 30 35 40

Yes - they already have this capability

Yes - within two years

Yes - within five years

Yes - more than five years from now

No

Don't know

39.4%

16.9%

12.7%

1.4%

14.8%

14.8%


21/2821

Which regulators could potentially bring enforcement actions against your organization?(Respondents were allowed to choose multiple responses)

Industry oversight emanates from multiple sources. Respondents expressing opinions about any enforcement that

government agencies could bring against them identified three agencies with such authority. This also suggests that

firms, to varying degrees, have both physical and financial oversight.

FERC was the number one agency named, with 64 percent of respondents identifying it as a potential source of

enforcement actions, closely followed by CFTC, at 58 percent. More than a quarter of the respondents identified

criminal actions by DOJ as a possibility.

The US markets are not the only regions for which respondents expressed concern, as one-eighth of those surveyed

have overseas exposure. Firms need to ensure their employees are well versed in all possible regulatory actions.

58.5%

64.1%

37.3%

28.9%

26.8%

0 10 20 30 40 50 60 70 80

CFTC

FERC

FTC

SEC

ISO/RTO

DOJ

FSA

Don't know

Other

20.4%

12.7%

14.8%

16.9%


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22


What do you think is the maximum energy trading compliance fine your company could face?(Respondents could only choose a single response)

38 percent of respondents admit that they do not know what their own organization's exposure for non-compliance couldpotentially cost their companies. This demonstrates the need for compliance training.

How can employee decisions reflect the best interests of their organizations if they don't understand what is at stake?Without this basic knowledge, will they have sufficient interest in training and keeping current with changing rules?

0 5 10 15 20 25 30 35 40

Less than $5 million

$5-$9.9 million

$10-$24.9 million

$25-$49.9 million

$50-$99.9 million

$100-$149.9 million

$150-$200 million

Over $200 million

Don't know

29.6%

2.8%

4.9%

4.2%

3.5%

4.2%

0.0%

12.7%

38.0%

Do you believe the number of audits and enforcement actions taken against energy trading firms canbe expected to:(Respondents could only choose a single response)

Almost four-fifths of respondents expect the number of audit and enforcement actions to increase over time.

Based on the responses to this question, many industry stakeholders may be surprised to learn the number of investigationsand audits conducted by FERC in fiscal year 2009 were dramatically lower than 2008. According to FERCs 2009Report on Enforcement (issued December 17, 2009 in Docket No. AD07-13-002), FERC opened just 10 investigations in2009 versus 42 investigations in 2008, and conducted 33 audits in 2009 versus 60 in 2008.

The reduction in investigations and audits is certainly not due to budget cuts and staffing reductions. Enforcement fundsand staffing are on the rise. Instead, the reduction in numbers appears to be the result of FERC digging deeper and takingon more complicated issues than in the past.

A higher percentage of enforcement activities aimed at exposing more serious violations behind complex fact patterns,and the resulting possibility of more substantial penalties than in the past can be expected. Further, as FERC becomesmore familiar with this style of compliance enforcement, a likely return to double-digit percentage increases is possible inaudits and enforcement actions, leading to a new plateau that raises the bar for the industry.

0 10 20 30 40 50 60 70 80

Increase

Remain the same

Decrease

Don't know

79.6%

13.4%

0.0%

7.0%


23/2823

How would you rate the energy trading industry's readiness to comply with new energy trading rulesand regulations?(Respondents could only choose a single response)

Nearly one-half of respondents indicate that the energy trading industry has a less than acceptable ability to comply withnew energy trading regulations. The increasing rate of change will create even greater stress on internal complianceresources within companies.

If new energy market position limits rules and regulations are imposed by the CFTC, what will theimpact be on your organization?(Respondents could only choose a single response)

70 percent of respondents expect new CFTC position limits will not have a significant impact on their organization.

Early in 2010, the CFTC commenced a rulemaking proceeding to impose position limits in four exchange-traded energyfutures contracts, which has now been withdrawn in lieu of a rulemaking to impose position limits as required under theDodd-Frank Act. The Dodd-Frank Act significantly expands the scope of new position limits beyond those previouslyproposed by the CFTC. The Dodd-Frank Act requires the CFTC to establish regulations imposing position limits for contractsbased on the same underlying commodity across various markets, including exchanges, swap execution facilities, certain

foreign boards of trade, and swaps that perform a significant price discovery function.

Though the details of these new rules have not yet been developed and finalized, the complex set of aggregate limitsrequired by Dodd-Frank will likely have a more significant impact on energy market participants than the limits initiallyproposed by the CFTC.

0 10 20 30 40 50

Poor

Somewhat acceptable

Acceptable

Good

Excellent

Don't know

7.6%

41.5%

27.1%

11.0%

2.5%

10.2%

0 5 10 15 20 25 30 35 40

No impact

Minimal

Moderate

Significant

Very significant

Don't know

7.7%

24.8%

37.6%

12.0%

4.3%

13.7%


24/28


24


What market impacts may occur if proposed financial regulatory reforms become law?(Respondents were allowed to choose multiple responses)

To the research participants, negatives seem to greatly outweigh positives. About two-thirds predict increased transactioncosts and a reduction in market liquidity. About half foresee a reduction in available credit and counterparties. More thanone-third expect to see reduced structured transactions and movement of trading oversees.

In contrast, only about a quarter of the respondents expect the changes to result in increased transparency, and fewer thanone-fifth believe the changes will result in a systematic reduction in risk.

0 10 20 30 40 50 60 70 80

Reduction in available credit

Reduction in market liquidity

Reduction in structured transactions

Reduction in counterparties

Increase in transaction costs

Movement of trading activity to overseas market centers

Increased transparency

Reduction of systematic risk

None

Don't know

Other

51.3%

65.0%

43.6%

55.6%

66.7%

36.8%

27.4%

17.1%

0.9%

12.0%

4.3%


25/2825

In what type/part of an organization do you work?(Respondents were allowed to choose multiple responses)

Demographics/Respondent Profile/Research Background

Research participants represent a range of energy industry organizations, including investment banks (4.2%), but the largestparticipation came from entities operating in the natural gas (44.4%) and power (40.8%) sectors.

Within the Other category (23.2%), participation came from a range of entities, including broker/dealers, hedge funds,and consulting firms.

Select the category that best describes your organization/role.(Respondents could only choose a single response)

Respondents include a range of energy market participants, from producers (13.4%) and funds (2.8%), to utilities (28.9%)and marketers (24.6%).

Others (22.5%) describe themselves in a variety of roles, indicating some knowledge of the trading area.

0 10 20 30 40 50

Oil

Natural Gas

Power

Natural Gas Liquids

Investment Bank

Regulator

Other

17.6%

44.4%

40.8%

7.0%

4.2%

0.0%

23.2%

0 5 10 15 20 25 30

Producer

Marketer

Fund

Utility

Consumer

Midstream

Retail

Other

13.4%

24.6%

2.8%

28.9%

4.2%

2.1%

1.4%

22.5%


26/28


26


How large is your organization's annual wholesale energy transaction portfolio (in U.S. dollar value)?(Respondents could only choose a single response)

Respondents represent organizations with energy transaction portfolios of varying sizes. While almost one in fourrespondents represent organizations with modest annual wholesale energy transaction portfolios of less than $50 million,more than one in 10 represented organizations with large transaction portfolios greater than $10 billion.

Which of the following best describes your work area?(Respondents could only choose a single response)

More than 56 percent of respondents identify themselves as working in trading, risk management, or compliance, withtrading accounting for the largest representation at 21.1 percent.

Nearly 15 percent of respondents identify themselves as working in senior management.

0 5 10 15 20 25

Below $50 million

$50 million to $149.9 million



$1 billion to $2.9 billion

$3 billion to $9.9 billion

$10 billion and above

23.7%

13.2%

9.6%

14.0%

15.8%

12.3%

11.4%

0 5 10 15 20 25

Executive Management

Internal Audit

IT/Information systems

Compliance

Risk Management

Legal

Trading

Origination/Marketing

Production/Assets

Other

14.9%

0.9%

3.5%

14.9%

20.2%

8.8%

21.1%

7.0%

0.0%

8.8%


27/2827

In what region do you as an individual participate in your company's activities?(Respondents were allowed to choose multiple responses)

The vast majority of respondents (93.9%) indicate participation in activities within their organizations North Americanoperations.

Participants also indicate involvement in activities across the globe, particularly in the United Kingdom, Western Europe,and Asia.

0 20 40 60 80 100

North America

South America

United Kingdom

Western Europe

Eastern Europe

Middle East

Asia/Pacific

Africa

Australia

Other

93.9%

4.4%

7.0%

6.1%

1.8%

1.8%

7.9%

1.8%

3.5%

3.5%


28/28

About NICE Actimize

NICE Actimize is the world's largest and broadestprovider of a single financial crime, risk and complianceplatform for the financial services industry. NICE Actimize

empowers its clients to prevent financial crime, mitigaterisk, reduce operational costs, minimize losses andimprove compliance. The company provides real-timeand cross-channel fraud prevention, anti-moneylaundering, enterprise investigations, risk managementand trading surveillance solutions; built upon theActimize Core Platform which has been enhanced by thecompany's acquisitions of Syfact and Fortent(Searchspace) analytics and technology. With officesacross North America, Europe, Asia and the MiddleEast, NICE Actimize serves the majority of the worldslargest financial institutions including all of the top 10global banks. www.actimize.com

For more information about how NICE Actimize hashelped energy firms address compliance requirementsand how we can help your organization build aneffective energy compliance program, contact Actimizeat 212-643-4600 or [email protected]

About Fulbright & Jaworski L.L.P.

Fulbright & Jaworski, in business since 1919, is recognizedas one of the leading oil & gas law firms in the United Statesby Chambers USA 2010 and this is due in part to the fact

that six of our energy regulatory lawyers were recognizedindividually by Chambers. Our energy regulatory group iscomposed of highly experienced lawyers who provide a fullrange of services in energy regulatory matters, includingnatural gas regulation, crude oil and petroleum productregulation and electric power regulation. This team includesseasoned lawyers formerly with the CFTC, the FERC, the U.S.Department of the Interior, and the U.S. Department ofJustice as well as a former general counsel of a major energycompany. We have a broad regulatory practice geared tohelping our energy clients cope with the complex andchanging regulatory schemes affecting their businessoperations, including the trading of energy commodities.

www.fulbright.com

For more information about how we can help yourorganization build an effective energy compliance program,please contact Erik Swenson ([email protected] or202-662-4555) or Michael Loesch ([email protected] 202-662-4552).

actimize energy trading compliance research 2010

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