With oil prices below $40 per barrel and natural gas prices fl at from well-head to burnertip at around $2 per million Btu, it doesn’t take an economist to know change is inevitable. The ability to adapt is key to the survival of any organization.

While innovation during times of adversity is often a good thing, with change can come compliance risk, which translates directly to financial risk. Prudence dictates that in the current enforcement climate, change must be accompanied with a sensitivity to how new strategies may be perceived by regulators.

In the past year, two cases brought by the Federal Energy Regulatory Commission (FERC) and the U.S. Commodity Futures Trading Commission (CFTC) have highlighted the significance of change and the importance of identifying compliance risks whenever facing new conditions or strategies. Whether that change comes in the form of adjustments to business plans or strategies, transfers of ownership in companies or assets or new market supply and demand fundamentals, change can lead to missteps in compliance and can be used as evidence of manipulation.

Asking questions in the face of change can save millions of dollars in civil penalties and avoid the cost, inconvenience and embarrassment of an investigation.

With both agencies aggressively testing their $1 million per day/violation penalty authority, compliance mistakes have never been more costly, and a push toward individual liability has caused the compliance risk to become more personal. These pressures make the correlation between change and compliance risk worth attention in a climate ripe for change.

BP America Inc.

On Aug. 13, 2015, the administrative law judge assigned to hear evidence in BP America Inc. et. al (Docket No. IN13-15) found that BP America Inc. (and certain of its affiliates) engaged in market manipulation by intentionally trading to influence index prices to benefit a related financial position. The judge’s decision is currently being reviewed by FERC, but even were it to be reversed, the lessons it provides regarding the significance of change will remain.

Whether it be changes in the timing, location, size, or the nature of trades, or changes in the profitability or transportation associated with trades, regulators are looking for changes in trading patterns and will call upon market participants to explain the changes.

In the case, the following are key changes in activity that were taken together to allege market manipulation. BP America:

• Increased volume and percentage of fixed-price sales at a single location (viewed as a “marker” for manipulation);

• Began buying natural gas earlier in the morning (previously, on average, 20 minutes after the first trade, then within 27 seconds). “Early bid hitting” was viewed as evidence that BP intended to “mark” or “frame” the open;

• Increased the number of trades resulting from hitting bids, which was viewed as an “effective way of selling at the lowest possible price” and signaling to the market an “anxious” seller;

• Increased market share in the next-day, fixed-price market (especially early);

• BP increased the size of financial positions priced to indices at points where it transacted in fixed-price trades;

• Increased usage of pipeline transport and increased losses associated with transport; and

• Made less money on physical trades compared to before and after the time in question, which was interpreted to show BP intentionally traded uneconomically.

Both the Division of Analytics and Surveillance at FERC and the Division of Market Oversight at the CFTC monitor trading patterns and initiate inquiries based on these types of changes in behavior.

Anticipating the perception of changes in strategies can help companies avoid inquiries or help them ultimately to prevail if changes prompt allegations. Vetting new strategies prior to execution and recognizing changes in behavior as triggers for compliance reviews can help mitigate the risk of an investigation and reduce the risk of an actual or perceived violation.

CFTC vs. Kraft Foods

The CFTC also last year brought a case that turns in large part on changes in behavior. In CFTC v. Kraft Foods Group Inc. and Mondelez Global LLC, the CFTC is alleging that Kraft Foods manipulated the wheat futures and cash markets in 2011. While the case involves an agricultural commodity, the statute under which the case is being brought applies to all commodities, and the case is another example of the correlation between change and compliance risk.

According to the complaint, Kraft historically procured its wheat supply primarily in the local Toledo, Ohio, cash market and used wheat futures to hedge its cash purchases, rarely taking delivery of wheat via the Chicago Board of Trade delivery process. However, in late 2011, the cash market was trading at a premium to the futures market and, according to contemporaneous emails quoted in the complaint, Kraft estimated that it could save more than $7 million if it sourced wheat in December 2011 through the futures market rather than through the cash market.

The CFTC’s case turns in part on the allegation that Kraft intentionally sent a false signal to the market that it intended to take delivery of its futures position. As evidence that Kraft never intended to take delivery, the CFTC points to, among other things, changes in the size of its futures position. Historically, Kraft had maintained about two months’ supply of wheat in inventory, but during the relevant period, Kraft appeared to be poised to purchase enough wheat to give it six months’ supply.

This case is being litigated in federal court after the defendants’ motion to dismiss was denied in December. However, the importance the CFTC has placed on the historical behavior compared to the behavior in question—highlighting the change in amount and manner of procurement—underscores the importance of evaluating compliance risk with every change in behavior.

Recognizing compliance risks Comparing these two pending cases to a case settled in 2014, we see that recognizing changes in activities as compliance red flags can save money. In August 2014, FERC issued an order approving a settlement resolving allegations of market manipulation against Direct Energy Services Inc. FERC has since showcased this settlement and Direct Energy as a textbook example of the benefits of an effective compliance program.

The settlement resulted in Direct Energy paying a $20,000 civil penalty while others have been ordered to pay $28 million, $135 million and $435 million in civil penalties for violations of FERC’s anti-manipulation rules. While Direct Energy received credit for self-reporting the conduct in question, the difference in outcome may also be attributable to Direct Energy stopping the conduct quickly before substantial “unjust” profits could be accrued or harm to the market experienced.

The discovery by the back office underscores the value of evaluating changes in behavior even when the changes alone do not suggest wrongdoing.

As a result of identifying the activity and stopping it quickly, FERC staff concluded that the trading occurred on only seven days, and enforcement calculated the harm to the market as $69,019. Compare this to the facts outlined in the Constellation settlement, in which FERC staff found Constellation had engaged in prohibited conduct for 16 months and obtained about $110 million in unjust profits. Constellation agreed to pay $135 million in civil penalties and to disgorge about $110 million.

Similarly, in a case against Barclays currently pending in federal district court, FERC staff is seeking $435 million in civil penalties for conduct occurring over about two years and resulting in about $34.9 million in profits.

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