Category Archives: US Constitution

The Investors at War With Political Power

Rather long, but folks – we need to start paying attention to “the government of ours’ which ‘managers’ of which are more and more thinking they can do as they wish.
How a once-obscure federal agency targeted two brothers, and what happened when they decided to fight back in the age of Obama.
By JOSEPH RAGO CONNECT May 2, 2014 6:45 p.m. ET West Chester, Pa.

There’s a quote hanging on the wall of Rich Gates’s office, here in a suburb west of Philadelphia: “No person, in any culture, likes to be bullied. No person likes living in fear because his or her ideas are different. Nobody likes being poor or hungry, and nobody likes to live under an economic system in which the fruits of his or her labor go unrewarded.” President Obama, in his book “The Audacity of Hope,” meant those words as inspirational; for Mr. Gates, they are ironic.

Late last summer Mr. Gates and his identical-twin brother, Kevin, learned in a letter from the government that they were being accused of having manipulated electricity markets, a serious fraud violation. After a three-year investigation, federal energy regulators had concluded that two of their investment partnerships, known as Powhatan and Huntrise, had “profited, intentionally so” from sham power trades. The Gates’s reply to the 28-page document, in its entirety:

“Your preliminary findings make no sense. Should you choose to proceed with a public notice against Powhatan and/or Huntrise, please be advised they will respond publicly and forcefully.” The Gates brothers debated whether the second sentence was redundant. By then, they had decided they wouldn’t be bullied any longer.

The brothers went public with an earth-scorching campaign against their treatment by the Federal Energy Regulatory Commission, or FERC. They’ve released hundreds of pages of internal documents that aren’t normally disclosed during an ongoing investigation, and FERC is not pleased. This is not supposed to happen, and never has.

Rich Gates says he was “completely dumbfounded” by FERC’s legal and financial reasoning. “We wanted to go open kimono,” Kevin Gates adds, “and just provide full transparency into the process to the public at large.”

The Gates case offers a rare glimpse into FERC’s prosecutorial method and the workings of the larger regulatory state in the Obama era. Since 2009, the commission has transformed itself from the boring regulator nobody ever heard of into a fearsome scourge of Wall Street and U.S. business. To great political acclaim, FERC’s Office of Enforcement has pursued everybody from big financial institutions like Barclays BARC.LN -1.33% and Deutsche Bank DBK.XE +0.03% down to individual traders and even Maine paper mills, making market-manipulation charges much like those lobbed at Powhatan and Huntrise.

FERC’s most notable scalp so far is a $410 million settlement last year with J.P. Morgan JPM -0.37% that happened to land amid the London Whale and mortgage securities political pile-on. The White House thinks well enough of the enforcement division’s work that the administration wants to promote its director, Norman Bay, to FERC chairman.

The problem is that no one understands what FERC’s definition of “market manipulation” is, only that, like Justice Potter Stewart, Mr. Bay knows it when he sees it. Though the financial stakes for the Gateses aren’t high in the scheme of things—$4.7 million in allegedly ill-gotten profits, by FERC’s reckoning—the brothers think that their reputations are worth defending. Alone among FERC’s targets, they’re doing what they promised, publicly and forcefully.

“This particular adventure began in 2008 when we cold-called Alan Chen, ” Kevin Gates says. Dr. Chen was a Houston energy trader with a Ph.D. in power engineering, and his strategy appealed to the Gates brothers. They and their friends and family set up a fund, Huntrise, which would reflect Dr. Chen’s plays.

The fund was a side investment for their personal portfolios. Their day jobs are managing a midsize advisory firm called TFS Capital. Rich Gates is among the heroes of Michael Lewis’s “Flash Boys,” and the Securities and Exchange Commission considers him a Dodd-Frank whistleblower for his role in exposing some high-frequency trading practices.

The trades on FERC trial are less exotic. Megawatts can be bought and sold like any other stock or commodity in about half the country where competitive wholesale power has replaced the old state utility monopolies. Dr. Chen was trading in a large regional market called PJM Interconnection, a transmission grid organization that covers all or most of 13 mid-Atlantic states out to Ohio.

He was placing bets on the spread between the day-ahead and real-time price of electricity, focused on rare but very profitable events that could not be known in advance. Think of a batter swinging for a home run on every pitch even if he strikes out most of the time.

Then one day in November 2009, Dr. Chen received a surprise reimbursement from PJM, retroactively paying him an honorarium for some of his past trades. He was the beneficiary of a running debate within FERC over “fairness” and who should pay for the fixed costs of electric transmission.

FERC favors the bafflingly complex over the straightforward and efficient, but to oversimplify, all buyers and sellers pay various tariff charges to participate in PJM. The process is designed to collect more of these up-front fees than transmission costs in practice. “Basically there’s a big pot of money left over that PJM has to allocate,” Kevin Gates explains.

This redistribution largely had gone to grid operators that physically flowed power through the transmission lines. But then FERC decided that since traders like Dr. Chen were also required to prepay the tariff charges, they deserved to be cut in on the rebates too. He realized—it takes a doctorate in the sciences to understand the formula’s technicalities—that at certain predictable geographical hubs in PJM and at certain predictable times, the rebates would be significant and higher than the tariff charges. As it turned out, the system would sometimes pay him to make trades.

“We liked the investment to begin with, that’s why we had money with Alan,” Kevin Gates says. “Now we have this tailwind. We were collecting rebates in addition to the normal exposure we were getting. Therefore the natural, logical response is, let’s increase our exposure.”

Another way of putting it is that since the cost of swinging was lower, the Gates brothers could try for more home runs. Around this time they founded Powhatan and ramped up their trading volume over six months in 2010. Of the Gates brothers’ initial $2 million investment, Dr. Chen lost over $400,000 in the first two days, though he went on to grow the investment to $7 million in a matter of weeks.

That drew the ire of FERC’s enforcement division, which began demanding information and taking depositions in fall 2010. At first, the Gates brothers tried to adhere to the insider playbook and hired an attorney from White & Case, a D.C.-based law firm that does frequent business in front of FERC. The insular Washington energy bar trafficks in political connections, but those aren’t so useful for clients who maintain their innocence.

Things started to turn for Kevin Gates, he recalls, during his second full-day deposition with the lead FERC enforcement lawyers on the Powhatan matter, Steven Tabackman and Thomas Olson. “I would suggest that it was intimidation tactics, aggressive behavior, which I guess is natural for a federal prosecutor, maybe what you would expect,” he says. “But there were also a lot of questions asked and behavior that suggested to me that we were seeing the world very differently and—I would suggest—they didn’t know what they were talking about.”

Mr. Gates was asked to leave the room and sat in the hallway while his lawyer conferred with the feds. The lawyer emerged to relate what the FERC enforcement team had proposed: “Kevin’s a businessman, isn’t he? He knows that it’s cheaper to settle than it is to fight this investigation.” Right then, Mr. Gates says, “I realized that we had a big problem on our hands. This was unlike anything we’d ever seen before at a regulatory agency.”

The Gates brothers fired the white-shoe practice and brought on Bill McSwain of Drinker Biddle, a Philadelphia-area lawyer who “didn’t interface much with FERC. He also used to be a Marine sniper, so he had a different approach to the world.” Mr. McSwain introduced himself to FERC by calling their conduct contrary to “established law, as well as common sense,” and that was one of his subtler letters.

Ultimately FERC claimed that Powhatan was making trades merely to harvest the PJM rebates, not transactions that had a legitimate economic purpose or generated real value. FERC calls them “wash trades.”

Yet FERC doesn’t seem to understand the difference between a wash trade and a washing machine. By definition wash trades make no money and entail no risk—a trader makes near-simultaneous purchases and sales of the same security. They can be self-dealing or used to trick another investor or inject bad information into the market. As Rich Gates put it, “Alan Chen’s trades were very different. They were spread trades that were designed to make money by themselves, they didn’t benefit some other entity, they weren’t designed to deceive. They were designed with the sole purpose of making money.”

More to the point, the Gates brothers make a compelling argument about due process. FERC debated the transmission rebates, vetted the consequences, and then wrote rules that opened the PJM rebates to traders. The commission itself had expressly predicted in a 2008 ruling that if arbitrageurs “can profit from the volume of their trades,” they “may make trades that would not be profitable based solely on price differentials alone.”

In other words, even if the Gates brothers were trying to amass rebates and nothing else, that was not illegal or illegitimate at the time, and FERC never gave fair notice suggesting otherwise. Instead, years later, the commission decided that it didn’t like the outcomes that it anticipated from the incentives it created, and decided to selectively punish some investors ex post facto. If in hindsight FERC thinks the results of obeying its rules are undesirable, then the commission should either make better rules or else give investors like the Gates brothers a public-service medal for exposing its own mistakes.

FERC did end up changing the rules, again. The rebates for traders stopped. But the assault on Dr. Chen and the Gates brothers has continued. FERC even views their efforts to exonerate themselves as compounding the original offense, such as it is.

The Gates brothers hired as consultants an all-star roster of experts in power and securities law to independently examine the facts of the case. They include Harvard’s Bill Hogan and Richard Tabors, formerly of MIT, who were the architects of the electric-deregulation movement. Another is Craig Pirrong of the University of Houston, probably the world’s leading authority on commodity-market manipulation. With their own credibility to maintain, not one supported FERC.

One of the experts, Susan Court, FERC’s former enforcement director, had “a very short meeting” with her successor, Mr. Bay, as a gesture of good faith. She informed him of what the Gates brothers were up to. Ms. Court reported that Mr. Bay “was very upset and taken aback.” Perhaps he let that cloud his judgment, Kevin Gates says.

The brothers concluded, Mr. Gates continues, that “we can’t communicate effectively with the FERC,” so they’d try to persuade “our neighbors, our investors, our business partners.” They’ve uploaded all of their case files and correspondence to a public website, Mr. Gates says that, “It’s never good as a money manager or even just a citizen to have your name in the paper as a market manipulator, but we know we’re not going to settle.”

FERC still hasn’t brought public charges or formally closed the investigation. The Gates brothers have filed Freedom of Information Act requests for records relevant to their case so that they can disclose more, and they’re more or less daring FERC to sue. The brothers seem like they’d be delighted to vindicate themselves in a court of law.

Still, their treatment does raise troubling questions about Mr. Bay’s fitness and competence to lead the larger Federal Energy Regulatory Commission. Congress gave FERC market-manipulation oversight powers with teeth—including penalties of $1 million per day per violation—only in 2005, but those powers did not receive a real work-out until Mr. Bay joined FERC in 2009. He was formerly U.S. attorney for New Mexico.

Mr. Bay expanded the Office of Enforcement to some 200 staffers from 20 a decade ago, bringing in the likes of Mr. Tabackman, who was most recently a partner at Butzel Long Tighe Patton, where from 2002 to 2005 he was a consultant to the legal-defense team of 9/11 conspirator Zacarias Moussaoui.

These former criminal prosecutors and litigators have specialized in retroactive punishments for conduct that was legal at the time. Most of these cases never go to court and end with settlements against politically disfavored defendants like J.P. Morgan (that one, like Powhatan, was led by Mr. Olson). Most companies roll over because their future business interests depend on preserving good regulatory graces and favorable FERC rulings. The Gates brothers are unusual in that their livelihoods are elsewhere, but the illogic, intimidation tactics and erosion of due process in their investigation are typical.

The larger point is that the Gates case shows Mr. Bay and FERC are really undermining the electricity markets in the name of defending them. Ad hoc settlements win political plaudits, but because companies usually neither admit nor deny wrongdoing, the settlements set no meaningful or coherent legal precedents. Aside from mind readers and fortune tellers, no one can know what the rules—or, rather, what FERC’s subjective backward-looking interpretation of market manipulation—will be, depriving the markets of liquidity and price discovery. “Shooting random people for following the law,” says Rich Gates, “that sets the markets and the world back.”

Mr. Rago is a member of the Journal editorial board.

The Weekend Interview: The Investors at War With Political Power –


Standing to Sue

If this issue is not addressed and “we” continue to allow the executive branch to abdicate its accountability to enforce the laws of the land, I fear we will come to regret it.
The legal left and media are always last to know, but there are the makings of a correction in how the courts police conflicts between the political branches. President Obama’s serial executive power abuses—on health care, immigration, marijuana and much else—may be inspiring a heathy rejoinder.

Under the Constitution, Congress is supposed to create and amend laws and the President to faithfully execute them, but Mr. Obama has grabbed inherent Article I powers by suspending or rewriting statutes he opposes. The President has usurped Congress with impunity because he assumes no one has the legal standing to challenge him.

Most of the time people who are exempted from laws do not suffer the concrete injuries that the judiciary can redress, while the courts maintain a presumption that Members of Congress also lack such standing. In 1997’s Raines v. Byrd, the Supreme Court rejected a lawsuit against the line-item veto brought by six Congressmen because the loss of legislative power they challenged was a “wholly abstract and widely dispersed” injury.

But that doesn’t mean that conduct that marginalizes the legislative branch is absolved of judicial review. In one notable case, Wisconsin Senator Ron Johnson is suing the White House over the ObamaCare regulatory carve-out that conjured up special subsidies for Members and staffers who were supposed to give up federal employee health benefits to join the insurance exchanges.

Mr. Johnson argues that because Members must designate which staffers do and don’t participate, the rule imposes a nontrivial administrative burden—i.e., he has standing to sue because the rule harms his office, not because he is a U.S. Senator. More to the point, Mr. Johnson claims that the rule forces him to become personally complicit in law breaking and thus damages his political reputation. Several appeals court precedents hold that elected officials who must maintain the public trust suffer injuries when their credibility is undermined, including a 1993 D.C. Circuit ruling by now-Justice Ruth Bader Ginsburg.

The White House claims Mr. Johnson lacks standing, but that’s because the lawyers don’t want to get near the merits. The real import of his lawsuit is that it invites the courts to restore the proper separation of powers amid executive encroachment.

The Washington lawyer David Rivkin and Florida International University law professor Elizabeth Foley suggest a broader approach that doesn’t require legislators to act as individuals. They’re trying to persuade House leaders to mount an institutional challenge to the White House rewrite of ObamaCare’s employer mandate. Here the President is defying the plain language of laws and undermining legislative power. The courts ought to extend standing to the House as an institution to vindicate this injury. Short of impeachment, there is no other way for Congress to defend its constitutional prerogatives and the rule of law.

Earlier this year the Tenth Circuit used this theory to grant legislative standing to a group of liberal Colorado representatives to challenge that state’s taxpayer bill of rights. Last year the Supreme Court also granted standing to Congress’s Bipartisan Legal Advisory Group to defend the Defense of Marriage Act.

The White House had refused to advocate for DOMA based on a constitutional theory that then had no established judicial precedent. The Court ruled in Windsor that deliberately making the Defense of Marriage Act a legal orphan “poses grave challenges to the separation of powers for the Executive at a particular moment to be able to nullify Congress’s enactment solely on its own initiative and without any determination from the Court.”

All this recalls the revival of federalism under the William Rehnquist Supreme Court. From the New Deal to the late 20th century there were few tangible protections of the powers the Constitution reserves to the states or the people, and any doctrine that limited federal incursion was assumed a dead letter.

But beginning with the 1992 landmark New York v. United States, the Court began to rediscover the government of enumerated powers that the framers envisioned. A 6-3 majority overturned a 1985 federal law that ordered states to dispose of radioactive waste within their own borders because “the accountability of both state and federal officials is diminished.”

The ballot box is the most important constitutional check on government, but voters can’t know whom to reward or punish if Congress impresses states into federal service. Political actors must “suffer the consequences,” Justice Sandra Day O’Connor held in N.Y. v. U.S., if their decisions turn out to be “detrimental or unpopular. But where the federal government directs the states to regulate, it may be state officials who will bear the brunt of public disapproval, while the federal officials who devised the regulatory program may remain insulated from the electoral ramifications of their decision.”

This jurisprudence turned on the “vertical” separation of federal and state power. Mr. Obama’s suspension adventures pose precisely the same questions about the “horizontal” division of powers, and the same logic applies. If the executive branch is allowed to rewrite or suspend statutes, it is harder and in some cases impossible for voters to know which parties and spheres of the government to hold responsible. Political accountability is undermined.

The legal establishment will dismiss Messrs. Johnson and Rivkin as cranks with no hope of success, but it has been wrong before. The President thinks he can disregard the laws, but judges are paid to defend them.

Standing to Sue Obama –


Is ObamaCare a Law?

Liberals keep dismissing challenges to ObamaCare, political and legal, so it’s no surprise they mostly ignored last week’s oral argument at the D.C. Circuit Court of Appeals that could send another case to the Supreme Court. Coming in the week the White House wheeled out its 38th rewrite of the law, Halbig v. Sebelius is even more important for the contours of executive power and the rule of law.

The case asks whether the Affordable Care Act, which limits insurance subsidies to “an Exchange established by the State,” also authorizes subsidies for the 36 exchanges established by the federal government. The courts tend to give the executive branch deference in interpreting ambiguous statutes, but here the Administration is asking the court to declare that the statute unambiguously means the opposite of what the plain language says.

This ought to be a straightforward matter of statutory construction. Democrats put conditions on the subsidies to pressure Governors to join ObamaCare on the familiar U.S. federal-state cooperative model, but they never anticipated lasting unpopularity and opposition. To resolve this political problem, the IRS brushed off the statute and expanded the subsidies to both types of exchanges.

Arguing before a three-judge panel, Assistant Attorney General Stuart Delery pointed up “interpretive tension” among various complex provisions. But he also suggested that reading the text literally would undermine ObamaCare’s purpose and structure of a nationwide system of subsidized health care. Try to parse that one: This is a law that its defenders argue will self-destruct if implemented as drafted by its architects.

Echoing liberal supporters of the Administration, Judge Harry Edwards repeatedly accused plaintiffs counsel Michael Carvin of purely political motives. “What you’re asking for is, come on, put it on the table: Destroy the individual mandate, which guts the statute. That’s what this case is about. There’s nothing hidden about that.”

That’s pretty rich given that the White House has itself gutted the individual mandate for its political purposes. Mr. Carvin represents taxpayers and businesses who would be otherwise exempt from ObamaCare mandates if the subsidies were withheld in their states, and thus will suffer injuries under the unlawful IRS rule. Judge Edwards went on to angrily demand: “Who cares? What difference does it make who sets up the subsidy? . . . You have a provision that says the state’ll do it, the feds’ll do it—what difference does it make who does it?”

Well, the states care a great deal about their rights and responsibilities under dual sovereignty federalism. Taxpayers also have an interest in overturning an IRS rule that exposes them to tax liability harm.

But the larger “who cares?” question turns on fidelity to the law and what obligation if any judges have to salvage an unworkable or badly designed program created by the political branches. As Judge Thomas Griffith ruminated, “If we know a clear purpose of Congress, and they don’t legislate clearly enough to achieve that purpose, is it our job to fix the problem?”

Democrats clearly had the grandiose “purpose” of national health care in mind, among hundreds of other motives in transforming one-sixth of the economy. But their sausage-making was also marbled with flaws, as its multiple administrative rewrites show. Their regrets over their own mistakes do not now entitle them to create statute-editing powers on the fly, which would be the result if the judiciary endorses a President’s power to enforce only those parts of laws he likes.

And would vacating the IRS rule really “gut” ObamaCare? It would surely complicate it. But then maybe more states would set up their own exchanges to get the subsidies. Or the White House could ask Congress to fix the law. President Obama conceded last summer that he favors “tweaks that don’t go to the essence of the law” and “in a normal political environment” he’d ring up John Boehner to negotiate a settlement.

But the President added that Republicans have an “ideological fixation” about ObamaCare, and therefore the ordinary legislative process is too fraught. But the Constitution doesn’t say Presidents can rewrite laws merely because asking Congress to change them would be difficult. The Administration’s real argument in Halbig is that interpreting the law as written would be politically bad so an accurate, faithful interpretation of the statute is out of the question. Judges aren’t supposed to lean on laws to produce partisan outcomes.

The “difference” it makes how Americans can access subsidies is between the faithful execution of the laws and anything-goes political and legal improvisation. As Chief Justice John Roberts famously wrote upholding the insurance purchase mandate, “It is not our job to protect the people from the consequences of their political choices.” It is also not their job to protect politicians from the consequences of their policy choices.

Is ObamaCare a Law? –


Freedom of Speech Wins

From Chief Justice John Roberts’s majority opinion in the Supreme Court’s April 2 decision in McCutcheon v. Federal Election Commission eliminating caps on the total amount of money that individuals can donate in a single election season:

There is no right more basic in our democracy than the right to participate in electing our political leaders. Citizens can exercise that right in a variety of ways: They can run for office themselves, vote, urge others to vote for a particular candidate, volunteer to work on a campaign, and contribute to a candidate’s campaign. This case is about the last of those options.

The right to participate in democracy through political contributions is protected by the First Amendment, but that right is not absolute. Our cases have held that Congress may regulate campaign contributions to protect against corruption or the appearance of corruption. At the same time, we have made clear that Congress may not regulate contributions simply to reduce the amount of money in politics, or to restrict the political participation of some in order to enhance the relative influence of others.

Many people might find those latter objectives attractive: They would be delighted to see fewer television commercials touting a candidate’s accomplishments or disparaging an opponent’s character. Money in politics may at times seem repugnant to some, but so too does much of what the First Amendment vigorously protects. If the First Amendment protects flag burning, funeral protests, and Nazi parades—despite the profound offense such spectacles cause—it surely protects political campaign speech despite popular opposition. Indeed, as we have emphasized, the First Amendment “has its fullest and most urgent application precisely to the conduct of campaigns for political office.”
Notable & Quotable.