On May 15, 2008, the Federal Energy Regulatory Commission ("FERC" or "Commission") issued a series of orders modifying and clarifying its enforcement processes. These orders will have a significant impact on all companies that may face audits, investigations, enforcement proceedings, or other issues regarding compliance with the Commission's rules and policies. Most importantly, the Commission reiterates its position that all regulated entities must have a culture of compliance and provides, for the first time, details regarding the elements that all internal compliance programs should contain. All companies subject to FERC jurisdiction should review these elements and modify their compliance programs accordingly.

The enforcement package includes a Revised Policy Statement on Enforcement ("Policy Statement"); a Final Rule on Submission to the Commission Upon Staff's Intention to Seek an Order to Show Cause ("Order No. 711"); a Notice of Proposed Rulemaking on Ex Parte Contacts and Separation of Functions ("NOPR"); and an Interpretive Order Modifying No-Action Letter Process and Reviewing Other Mechanisms for Obtaining Guidance ("Interpretive Order").

A. Policy Statement

The Policy Statement is essentially a guidebook addressing the Commission's enforcement process. The Policy Statement describes in detail FERC's investigative process and the process by which it determines whether sanctions should be imposed for particular conduct. The Policy Statement supersedes the Commission's first Policy Statement on Enforcement issued in 2005, but adopts a number of the provisions of the 2005 Policy Statement.

1. Investigations

When determining if an investigation should be opened, Staff examines a number of factors, including: (a) the nature and seriousness of the violation; (b) the nature and extent of any harm; (c) efforts made by the entity to remedy the violation; (d) whether the violations were widespread or isolated; and (e) whether the conduct was willful or inadvertent. The Policy Statement reiterates the Commission's practice of treating the existence of investigations and any documents disclosed during investigations as non-public information. The Policy Statement provides one important change in procedure — the subject of an investigation may, at any time, submit documents or information in writing directly to the Commission rather than to Staff.

If, at any time during the investigation, Staff determines that no violation occurred, the evidence is insufficient to warrant further investigation, or no further action is required, Staff may close the investigation. On the other hand, if Staff concludes that the subject of the investigation has committed a violation that warrants sanctions, Staff will notify the subject and provide a legal and factual explanation of its conclusions. The subject then has the opportunity to respond and furnish any additional information. If Staff continues to believe that sanctions are warranted, it will pursue settlement or the issuance of an order to show cause.

The Policy Statement discloses, for the first time, that Staff must obtain settlement authority — including a range of applicable sanctions — from the Commission prior to commencing settlement negotiations. Upon approval of the Commission, the stipulation and consent agreement, as well as the order approving the settlement, are made public.

If Staff and the subject of the investigation are unable to reach settlement, Staff may recommend that the Commission institute an enforcement proceeding by issuing an order to show cause. Unless unusual and exigent circumstances are present, Staff will notify the subject of its decision and advise the subject that it may make a submission directly to the Commission regarding the potential show cause order. As the Commission indicated in December, 2007, if it issues an order to show cause, it will attach Staff's report to the order, but will make no findings of fact. Issuance of an order to show cause commences a formal proceeding under Part 385 of the Commission's regulations. These proceedings are public. Moreover, if the NOPR's proposals (described below) are adopted, the Commission will designate certain Enforcement Staff as non-decisional at this point.

2. Elements of compliance programs

The Commission provides new information regarding its views on a company's "commitment to compliance." The Commission will examine whether the company has an established, formal compliance program supervised by a high-ranking official with independent access to the CEO or the Board of Directors, whether compliance is supported by senior management, the frequency with which the company reviews and modifies its compliance program and provides training to employees, and how the company responded to prior violations. The Policy Statement also makes clear that it expects companies to institute disciplinary consequences for employees who violate Commission rules. Companies subject to Commission regulation should examine their compliance programs to determine if they meet these guidelines.

In addition, the Policy Statement provides details about what the Commission may require a company to include in its internal compliance program. A program should include periodic employee training, a high-level compliance officer reporting to the CEO or to the Board of Directors, sufficient funding, measurable performance targets, tying employee and management evaluations and compensation to compliance, disciplinary consequences for employees that commit violations, internal Hotlines to permit employees to report possible violations, and comprehensive compliance audit programs. Yesterday the Commission scheduled a public workshop to discuss the elements that should be contained in compliance programs. The workshop will be held at the Commission's offices from 9:30 am to noon ET on July 8, 2008. The workshop will not be available as a webcast nor will it be transcribed.

As the Commission has made clear that a strong internal compliance plan is one of the two most significant factors to be considered in setting penalties, all entities subject to the Commission's jurisdiction would be well-advised to review and revise their current compliance plans to be sure that they meet the FERC's new guidelines.

3. Possible Sanctions

The Policy Statement discusses a number of enforcement tools available to the Commission, including: imposition of compliance plans; disgorgement of unjust profits; the ability to condition, suspend, or revoke market-based rate authority, certificate authority, or blanket certificate authority; the ability to refer matters to the Department of Justice for criminal prosecution; and civil penalty authority. As noted above, the Policy Statement provides details regarding the elements to be included in a comprehensive compliance program.

The Policy Statement declines to provide a "penalty matrix," instead leaving the Commission with broad discretion to determine the amount of civil penalties appropriate in particular circumstances. In determining the appropriate amount of a penalty, the Commission looks to several factors, including the seriousness of the offense, the company's commitment to compliance, whether the violation was self-reported, whether the company's cooperation with the investigation was exemplary, and whether the company previously sought Commission guidance regarding the conduct now being sanctioned.

One important clarification to existing FERC policy is that the Commission states that a party may, in good faith, challenge Enforcement Staff's legal theories, discovery requests, or other efforts without being deemed to be "uncooperative." On the other hand, in a decision issued on May 19, 2008, the Commission severely penalized Edison Mission for not cooperating with Enforcement Staff during an investigation. Edison Mission admitted to providing Staff with misleading information during the course of an investigation and agreed to a settlement providing for a $7 million civil penalty and the adoption of a comprehensive compliance program that may cost $2 million to implement.

B. Order No. 711

As noted above, if Enforcement Staff and the subject of an investigation do not reach settlement, Staff may recommend that the Commission initiate show cause proceedings. Order No. 711 requires Staff to notify the alleged wrongdoer of this recommendation, unless exigent circumstances require immediate Commission action. Order No. 711 also requires Staff's written recommendation to institute such proceedings to provide sufficient information and facts to provide the subject with notice of the basis for the recommendation. Order No. 711 makes clear that an alleged wrongdoer has the right to submit a written response to the Commission in the event that Staff recommends a show cause proceeding. Specifically, the party may make such a submission within 30 days of receiving Staff's notice. The Commission will consider Staff's recommendation and the subject's submission prior to determining whether to issue an order to show cause.

C. Ex Parte Contacts and Separation of Functions NOPR

Once the Commission issues an order to show cause, the NOPR proposes that designated Enforcement Staff members be made non-decisional employees for the remainder of the proceeding. Those Enforcement Staff members declared to be non-decisional will either work with or act as litigation staff during the show cause proceeding, but will not be involved in the deliberative process leading to the Commission's ultimate conclusions regarding the allegations set forth in the show cause order. In addition, non-decisional employees are prohibited from conducting off-the-record communications about the investigation with any member of the Commission or its decisional staff.

While the NOPR correctly proposes to designate certain Enforcement Staffers as non-decisional, the NOPR does not disclose which Staff members will be so designated. Thus, companies may be faced with a situation in which the same Staff members that participated in its investigation serve as members of the litigation team in a show cause proceeding. Since the Enforcement Staff that participated in an investigation will have had access to non-public information from the company and may have been involved in high-level discussions regarding the merits of the proceeding with senior staff and/or the Commissioners who will later decide the case, their participation in the litigation process may place the company at a distinct disadvantage. We consider this disadvantage to be an important point that should be clarified by the Commission in a Final Rule.

With respect to the Commission's ex parte rules, the NOPR points out that those rules do not apply to investigations conducted under Part 1b of its regulations. Nonetheless, both the NOPR and the Policy Statement make clear that neither the Commissioners nor their assistants will receive oral communications from the subject of an ongoing investigation. Any such communications must be made in writing. In contrast, members of Enforcement Staff will be permitted to engage in oral communications with the Commissioners and their assistants.

Finally, the NOPR proposes to revise the Commission's regulations to make clear that intervention is not permitted as a matter of right in show cause proceedings arising from Part 1b investigations. This standard may encourage third parties to attempt to intervene in show cause proceedings. Currently, motions to intervene are rarely filed and usually denied.

D. The Interpretive Order

Finally, in the Interpretive Order, the Commission expands the scope of the "no-action" letter ("NAL") process through which a company may request guidance on whether particular transactions, practices, or situations would subject the company to enforcement action. In particular, the Commission will expand the scope of issues covered by NAL requests to include any issue that falls within the Commission's jurisdiction, except for those issues related to the licensing of hydroelectric projects, certification of natural gas pipelines, operation of LNG terminals, and electric reliability matters. The Interpretive Order also states that the Commission will no longer permit the withdrawal of non-confidential NAL requests, because both positive and negative responses to NAL requests can offer useful guidance to the industry. The Commission declined to mandate a particular response time for NAL requests, or to allow hypothetical or anonymous requests.

Expansion of the NAL process to cover additional issues is certainly a welcome change. The receipt of a favorable NAL response is not, however, binding on the Commission. While the Policy Statement provides that good faith reliance on Staff guidance will perhaps result in "mitigation credit," it seems that a company could still be subjected to significant penalties even if its conduct is in strict compliance with a NAL response. The better course may be for the Commission to signal that in most instances it will order the company to modify its behavior on a prospective change and impose only a minimal penalty when a company has reasonably relied on a NAL response.

The Commission also will implement a compliance help desk on its Web site to provide a mechanism to submit questions regarding compliance with the statutes, rules, regulations and tariffs that it administers.

E. Conclusion

The orders described in this alert provide the energy industry with substantial detail regarding the Commission's enforcement policies, goals and procedures. As noted, all entities subject to FERC's enforcement jurisdiction should review their compliance programs in light of the details provided in these orders.

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Questions regarding these orders may be addressed to the following Schiff Hardin lawyers:

Schiff Hardin LLP