A Shocking Probe Into JPMorgan's Energy Trades

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Once upon a time, in the early 2000s in the state of California, an "energy crisis" occurred. Although the symptoms included blackouts, sometimes for hours on end, as well as out-of-sight electricity price hikes, the crisis didn't actually involve energy, per se. The crisis, of course, was that energy company Enron was manipulating energy markets, causing artificial electricity shortages to run up prices, and keeping its true financial situation a secret.

Ten years later, it may have happened again -- at least the market manipulation part, and, perhaps, the lying. The Federal Energy Regulatory Commission has officially opened an investigation of JPMorgan Chase (NYSE: JPM  ) and its involvement in the California energy market, after asking nicely several weeks ago for specific documents and emails -- some of which it received, but others the bank balked at turning over, citing attorney-client privilege.

No charges, just allegations
FERC's concerns about electricity trading hanky-panky came to light in early July, when the agency filed a subpoena to force JPMorgan to cough up over two dozen emails that they claim are germane to the matter. Although the bank eventually submitted 28 of the emails requested, it claimed that the remaining 25 were privileged, so FERC filed a petition to press the issue, disputing that position. This action made public the identity of JPMorgan as the party being targeted in the probe.  

When the agency threatened to cut JPMorgan off from the energy market, the bank quickly claimed that it was all a big mistake; it just submitted the wrong information. New documents have been submitted, so time will tell whether or not the company illegally skimmed $57 million from the state's electricity market, as the California Independent System Operator alleges. Information given to the state-controlled ISO by JPMorgan in relation to the case is also suspect.

Been there, done that
The rumpus started when grid operators in the Midwest and California asserted that JPMorgan Ventures Energy Corporation was artificially bidding up electricity prices to the tune of $73 million. According to the LA Times:

The ISO controls two electricity markets, one for immediate purchase of energy and one for a day ahead. To entice bids, the ISO agrees to cover plant start-up costs from owners, which is called "bid cost recovery." Essentially, JPMorgan submitted bids to the day-ahead market that were so low as to be not really credible, but which were accepted by the computers as legitimate. Then, the bank placed very high bids on the real-time market. This guaranteed that JPMorgan never had to supply actual electricity, but still got paid the bid cost recovery fee.

Very tricky, but JPMorgan learned from the best. Both JPMorgan and Citigroup (NYSE: C  ) were bankers for Enron back in the day and, as the house of cards fell, were made to pay for their involvement in the scandal. Citi paid $101 million to the SEC, and JPMorgan $135 million. If you're wondering about the difference in penalty totals, JPMorgan paid more because, not surprisingly, it was less cooperative with regulators.

Both banks were found to have participated in elaborate shell games, the end result of which were loans from the banks to Enron in order to make Enron look as if it was making a profit. Apparently, JPMorgan did not learn that cooperation with federal inquiries is always cheaper and may have the added benefit of keeping your name out of the newspapers.

The feds won't be letting go of this bone
FERC admits that the investigation is in its preliminary stages, but the agency has been tough on those caught with their hands in the energy till lately. This past April, the agency sent out a notice of "alleged violations" to Barclays (NYSE: BCS  ) for trading violations in the California day-ahead electricity market in order to positively impact swaps they held in the markets. In January, FERC sent a similar notice to Constellation Energy, now part of Exelon (NYSE: EXC  ) , for escapades in the New York and New England markets that also benefited their own financial positions. Constellation settled up before the merger, forking over $135 million in civil penalties as well as a $110 million reimbursement to ratepayers.

The foregoing seems to intimate that JPMorgan will be paying a hefty fine, if found to be liable. This can be added to all of the other legal expenses that the bank has on tap, such as lawsuits regarding Libor, as well as the London Whale trading fiasco. Although it seems that customers of the bank are undeterred by huge scandals surrounding the bank, as reflected in a recent poll, all these millions of dollars do add up, even for a bank holding more than $400 billion in deposits. That issue may not bother customers too much, but I'll bet it certainly will start annoying investors, and soon.

The banking sector certainly has its ups and downs, but there are reasons why big players like Warren Buffett invest in some of the largest banks around -- like Wells Fargo. Want to know what Buffett knows that you don't? Take a look at our special report on Wells Fargo, on us -- to learn just what makes this bank such an attractive investment. Remember, it's free, so click here now.

Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase and Citigroup. Motley Fool newsletter services have recommended buying shares of Exelon. Motley Fool newsletter services have recommended owning stock and writing puts on Exelon. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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