On April 22, 2010, the Commodity Futures Trading Commission (“CFTC”) issued an order imposing remedial sanctions on San Diego Gas & Electric Company (“SDG&E”) for engaging in wash sales in violation of Section 4c(a) of the Commodity Exchange Act, 7 U.S.C. § 6c(a) (2006) (the “Order”).¹ The Order is significant because it provides guidance to market participants on the characteristics of a wash sale and how to avoid violations and penalties under the Commodity Exchange Act (the “CEA”).

In order to hedge its liquidity and risk management positions, SDG&E established a long position in New York Mercantile Exchange (“NYMEX”) natural gas futures contracts for delivery months August 2006 through October 2006 (the “Futures Contracts”). On one or more occasions between January 26, 2006, and February 2, 2006, SDG&E gave instructions to an introducing broker to place offsetting sale and purchase orders with NYMEX floor brokers. Notably, SDG&E placed the order to sell and the order to buy in the same phone call with the introducing broker and specifically requested that the prices for each order be at or near the same price. The Order notes that these instructions had the effect of liquidating and immediately reestablishing the Futures Contracts previously held by SDG&E without materially altering its futures market position.

Section 4(c) of the CEA makes it “unlawful for any person to offer to enter into, enter into, or confirm the execution of a transaction” that “is of the character of, or is commonly known to the trade as, a ‘wash sale’.…”² The CFTC defines a wash sale as “a transaction made without an intent to take a genuine, bona fide position in the market, such as a simultaneous purchase and sale designed to negate each other so that there is no change in financial position.”³ As explained by the Commission, wash sales are serious violations, even if they do not result in customer harm or significant market effect, because “they undermine confidence in the market mechanism that underlies price discovery.”⁴

The Order identifies three characteristics of a wash sale: (i) a purchase and sale; (ii) of the same delivery month of the same futures contract; (iii) at the same (or a similar) price.⁵ Apart from the above-stated factors analyzed by the CFTC, the most important characteristic of a wash sale is the intent to avoid making a bona fide transaction or taking a bona fide market position.⁶ In determining whether a wash sale violation has occurred, the CFTC will scrutinize whether the customer, at the time the relevant transactions were entered into, had the intent to specifically negate market risk or price competition.⁷ A customer negates market risk whenever such risk “is reduced to a level that has no practical impact on the transactions at issue.”⁸

Notably, the CFTC acknowledges that SDG&E did not engage in any fraudulent misconduct by placing the NYMEX orders resulting in a wash sale.⁹ However, as explained by the Commission, a legitimate economic purpose behind a customer’s actions is not a defense to violations of the CEA.¹⁰ Because SDG&E intentionally placed the futures orders at the same time with its introducing broker and intended for such transactions to be executed at or near the same price, the CFTC found that SDG&E knowingly engaged in conduct which constituted a wash sale in violation of Section 4(c) of the CEA.¹¹ To settle the violation, SDG&E paid the CFTC a civil monetary penalty of $80,000.¹²

If you have any questions or would like further information on this topic, please contact one of our Jackson Walker attorneys below for additional assistance.

Craig Enochs -  713.752.4315 - cenochs@jw.com

Cynthia Lam  - 713.752.4523 - clam@jw.com

Kevin Page - 713.752.4227 - kpage@jw.com

Paul Vrana - 713.752.4514 - pvrana@jw.com

¹ In the Matter of San Diego Gas & Electric Company, Order Instituting Proceedings Pursuant to Section 6(c) of the Commodity Exchange Act, Making Findings and Imposing Remedial Sanctions, CFTC Docket No. 10-08 (April 22, 2010).

² 7 U.S.C. § 6c(a) (2006).

³ Order at 3.

⁴ Id.

⁵ Id.

⁶ Id.

⁷ Id.

⁸ Order at 3 (quoting In re Piasio, [1999-2000 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,276 at 50,688 (CFTC Sept. 29, 2000), aff’d sub nom. Wilson v. CFTC, 322 F.3d 555, 559 (8^th Cir. 2003).

⁹ Order at 4, FN 2.

¹⁰ Id.

¹¹ Id. at 4.

¹² Id. at 5.