110 1 BEFORE THE UNITED STATES 2 FEDERAL ENERGY REGULATORY COMMISSION 3 4 - - - - - - - - - - - - - - x 5 In the Matter of: THE : 6 INVESTIGATION OF : 7 PJM UP-TOS CONGESTION : 8 TRANSACTIONS : 9 - - - - - - - - - - - - - - x 10 11 12 DEPOSITION OF RICHARD J. GATES (Continued) 13 REDACTED 15 16 17 18 19 Philadelphia, Pennsylvania 20 Tuesday, May 8, 2012 21 22 23 REPORTED BY: 24 DONALD R. THACKER 25 111 1 Deposition of RICHARD J. GATES called for further 2 examination pursuant to agreement of counsel, on Tuesday, 3 May 8, 2012, in Philadelphia, Pennsylvania at the, Offices 4 of Drinker, Biddle & Reath, One Logan Square, Suite 2000 at 5 8:43 a.m., before DONALD R. THACKER, a Notary Public within 6 and for the Commonwealth of Virginia, when were present on 7 behalf of the respective parties: 8 9 STEVEN TABACKMAN, ESQ. 10 JAMES C. OWENS, ESQ. 11 Attorney Advisors 12 Division of Investigation 13 Federal Energy Regulatory Commission 14 Office of Enforcement 15 888 First Street, Northeast 16 Washington, DC 20426 17 On behalf of FERC 18 19 WILLIAM M. McSWAIN, ESQ. 20 Drinker, Biddle & Reath, LLP 21 One Logan Square, Suite 2000 22 Philadelphia, Pennsylvania 19103-6996 23 215.988.2775 24 William.McSwain@dbr.com 25 On behalf of Powhatan and the witness 112 1 (May 8, 2012, 8:43 a.m.) 2 Whereupon, 3 RICHARD J. GATES 4 resumed the stand and, having been previously duly sworn, 5 was examined and testified further as follows: 6 EXAMINATION (Resumed) 7 BY MR. TABACKMAN: 8 Q We are on the record. Good morning, Mr. Gates. 9 Just to remind you, you are still under oath; do you 10 understand? 11 A I do. 12 Q Is there any reason today, medication, the way 13 you feel, that would disable you from giving full and 14 accurate testimony, understanding the questions, giving the 15 answers to the best of your ability? 16 A No. 17 Q The document that we had marked as Exhibit 3 -- 18 do you recall yesterday we were talking about Exhibit 2 19 where I was asking some questions about the document that 20 your brother Kevin prepared in regard to Alan Chen, the 21 opportunity with Alan Chen, he called it ramping up with 22 Alan Chen; do you recall that? 23 A Yes, I believe. 24 Q I believe you said, and again I believe my 25 recollection is reasonably accurate, you said Kevin was 113 1 excited about the possibility with Alan Chen of increasing 2 the business, investing more money with him? 3 A My recollection was I said of our relationship 4 with Alan, he was generally excited but sometimes he would 5 be more excited. It would have been slow, in his opinion, 6 and when the time when he sent out this presentation was 7 the time when he was probably more excited than normal. 8 Q And what is it, is there anything that you 9 recall -- strike that. 10 What was Kevin excited about, if you know? 11 A What I did know at the time or what I do know 12 today? 13 Q What do you know today? 14 A Looking back at that time, it appears that Kevin 15 was excited about the change in the marketplace that 16 provided transmission loss credits. 17 Q And you had received, by you I mean Huntrise 18 Energy Fund had received historical or retroactive payments 19 of transmission loss credits by that time; isn't that 20 correct? 21 A I don't recall. 22 Q Do you have any, do you recall that there was a 23 point in time where Huntrise was informed that PJM was 24 going to make payments of money that had been withheld for 25 Huntrise for this transmission loss credits going back 114 1 several years? 2 A Could you restate the question? 3 Q Do you -- Huntrise had received payments by that 4 time, I think on the order of $2.1 million, in historical 5 or retroactive transmission loss credits from PJM, going 6 back to December of 2007. 7 MR. McSWAIN: Are you asking him if he knows 8 that now or did he know it at the time? 9 BY MR. TABACKMAN: 10 Q Do you recall that happening? 11 A At that time I don't believe I was aware. I 12 have no recollection of being aware at that time in and 13 around summer of 2010 that payments were made retroactively 14 since the inception of the account, and I don't, am not 15 aware of that fact today, that at a certain time that 16 payments were made retroactively since the beginning of the 17 account. 18 Having said that, I am aware that at some point 19 in time, I am aware that we did receive payments after the 20 fact, maybe on a monthly basis over some period of time 21 after the fact, for credits or some additional income 22 stream. I do remember having received updates saying that 23 we made or lost X dollars on a monthly basis, but then oh, 24 my gosh, an extra Y dollars came into our account. 25 Q And -- but you don't know the rationale or the 115 1 source of those dollars, the source, the reason they were 2 being paid? 3 MR. McSWAIN: Again, be clear about what 4 timeframe in your answer. 5 THE WITNESS: At that time I had very limited 6 knowledge or understanding. I was made aware, I believe I 7 had a general sense that there were some incentives that 8 were provided or some rebates, if you will, that was 9 provided by the marketplace, that were either refunded or 10 paid into our account. 11 BY MR. TABACKMAN: 12 Q And again, at the time did you -- did Kevin 13 depict these payments to you that would be coming, these 14 transmission loss credits, as something that would have a 15 significant effect on the investment opportunity? 16 A I don't have a distinct recollection of any 17 statements that were made, but when you read this document 18 it appears that at that time he thought that it was an 19 important part of the investment strategy. 20 Q And which part of that document are you 21 referring to, and that is Exhibit 2; is that correct? 22 A Correct. On page two, the second -- third 23 sentence of the second paragraph says, this creates more 24 opportunities for Alan. 25 The last sentence of that paragraph says, he 116 1 hasn't heard -- he hasn't heard anything to suggest that 2 they will, but I think he feels this way because it is just 3 too easy for him to make money now, those sentences. There 4 are probably other sentences throughout this document that 5 lead him to believe that this was an important part of the 6 investment strategy. 7 The assertion, his idea that he had, the 8 thoughts that were going through his mind, were also before 9 we lost substantial money in our investment account. So 10 although he thought these were an important part of the 11 income stream, he sure, it is very apparent that he didn't 12 realize that, how much risk there was in this investment 13 with Alan Chen. 14 Q The second paragraph on page 2 does report, does 15 it not, that since May of 2008 Alan Chen had made 16 $3.6 million for the Huntrise Energy Fund, and that 17 Huntrise then paid him, in the next sentence, 40 percent of 18 that, netting $2.1 million? 19 A Could you repeat the question? 20 Q I said in the second or the third paragraph -- 21 A I understand that. 22 Q -- Alan began trading electricity for us in May 23 of 2008, and since then he has made about $3.6 million in 24 our account. We pay him 40 percent of that, so we have 25 netted about $2.1 million. 117 1 Did you know that? Let me ask you this, when 2 reading that, does that refresh your recollection as to 3 what you knew at the time? 4 A First off, my initial confusion with the 5 question is I wasn't sure which paragraph you were 6 referencing, but we are now looking at the first paragraph 7 of -- 8 Q The first paragraph is only one sentence, and I 9 missed that. That is a separate paragraph and I confused 10 you. 11 A The first paragraph I believe has two sentences 12 in it. 13 Q That is right, it is one line. 14 A The third paragraph does describe gains that 15 have been generated in the account by Alan Chen. I was 16 aware that he had, at that time I was aware that Alan Chen 17 had an incentive compensation structure such that he was 18 paid a percentage of our profits. 19 At that time I am not sure that I was aware what 20 percentage it was. In this paragraph Kevin is stating, 21 appears to be stating, that it was 40 percent. 22 Q You have no reason to doubt Kevin's accuracy on 23 that; do you, or the numbers that he reports, the amounts 24 of money? 25 A I am aware that there were negotiations with 118 1 Alan Chen on the Advisory Agreement that defined our 2 relationship with Alan, I am aware that the compensation 3 was part of that, the fee, advisory fees paid to Alan Chen 4 were part of that contract. And it would seem very 5 reasonable to me that that number could change as the 6 relationship evolved. In other words, it is very possible 7 that Kevin initially negotiated a fee split of X to Alan 8 and Y to us, and then subsequently those numbers evolved. 9 So when I see him saying 40 percent, I don't 10 know whether that was static throughout this duration of 11 the relationship, but something like that, I can assume 12 that when Kevin says that I interpret it that it was 13 approximately 40 percent during the duration of the 14 account, on average. 15 Q Okay. And my question wasn't for the entire 16 duration of the account. At the time that he reported 17 this, you have no reason to think that Kevin was wrong 18 about the percentage as of the date that this document was 19 written, which was March 7th, I believe, March 19 of 2010? 20 A When I read the third paragraph I interpret the 21 40 percent as described a compensation related to the 22 $3.6 million of what I believe are profits in the account. 23 So the 40 percent figure, to me, should be applied, since 24 the inception of the account in May of 2008, is the way 25 that I interpret that paragraph. 119 1 So at this specific point in time I am not sure, 2 I am not sure that Kevin is stating that the compensation 3 was exactly 40 percent at that point in time. 4 Q Why do you question, on what basis do you 5 question that as of the date that he is writing this he 6 would put in an inaccurate number, why do you think that? 7 A I don't think it is an inaccurate number, I 8 think that he is being very accurate. I have no reason to 9 believe that Kevin is being inaccurate in any way with 10 these numbers. What I am stating is that the 40 percent 11 figure is applied to the $3.6 million of profit that 12 occurred I presume from 2008 to March 4th, 2010, and that 13 our profits were $2.1 million. If the fee initially 14 started off at just for an example 50 percent fee split, we 15 get 50, Alan gets 50, and then in March -- May 2008, and 16 then at some period of time Kevin was able to negotiate a 17 40/60 split where we get 60 and Alan gets 40, say in the 18 summer of 2009, and then at this point in time, in 19 March 2010, Kevin could have negotiated a 70/30 split, 20 where we get 70 percent and Alan gets 30. But over the 21 entire duration on average it is a 60/40 split, but at this 22 exact point in time it is a 70/30 split. 23 Q So let me rephrase the question, because the -- 24 these possibilities of difference, you are just considering 25 things that are possible, you have no reason to believe 120 1 that that was in fact the case; is that right, or you have 2 no recollection that there was a change of some sort? 3 A Right, I don't remember the exact fees that were 4 negotiated. I do remember that the contract was negotiated 5 with Alan constantly and evaluated, and the terms of our 6 relationship, in terms of how much he was trading for our 7 account, how much he was trading for his account evolved. 8 Q Just to go back to the original question. You 9 have no reason to question, though, that when Kevin reports 10 that since May of 2008, that is since then the referencing 11 May of 2008 date, he has made about $3.6 million in our 12 account, you have no reason to doubt the accuracy of 13 Kevin's reporting on that; do you? 14 A No, rather I assume that Kevin's figure is 15 accurate. 16 Q And that the next statement we pay him 17 40 percent of that, so he we have netted $2.1 million, you 18 don't have any reason to doubt that fact, however, it may 19 have changed, your speculation that it might have changed 20 as opposed to having been 40 percent throughout, Alan was 21 paid 40 percent of the $3.6 million and you netted 22 $2.1 million out of that, you being Huntrise Energy Fund, 23 you don't doubt the accuracy of Kevin's reporting that; do 24 you? 25 A I do not. Rather I assume that he is -- his 121 1 opinion or thoughts are accurately described by what you 2 just said. 3 Q And you regard his reporting $3.6 million and 4 40 percent and $2.1 million as opinions of Kevin or facts 5 that he is reporting to his partners? 6 A I assume that he is reporting those as facts to 7 the best of his ability at that point in time. 8 Q And Huntrise Energy Fund kept books of its 9 accounts; isn't that correct? Wasn't that one of Greg 10 Sekelsky's jobs? 11 A Could you define books? 12 Q Accounting books, accounting books and records 13 of how much money came in to this account, how much was 14 profit, what its costs were, the percentages, I mean there 15 were things that Kevin could refer to in getting these 16 numbers? 17 A Correct. 18 Q The next sentence he says, until recently we've 19 only had about $300,000 posted in collateral. Earlier this 20 month we increased it to $500,000, and at the current ratio 21 of four times, we would likely need about 1 million in 22 collateral this summer since the credit requirements and 23 opportunities are seasonal. 24 Do you recall today any conversations that you 25 had with Kevin or anybody else at Huntrise Energy Fund at 122 1 that time about what the nature of this opportunity was and 2 the seasonality of it? 3 A I don't have any specific recollections of 4 conversations with Kevin or other investors or managers of 5 Huntrise Energy Fund about specific opportunities. 6 However, I am aware, was aware at that time, that in 7 general there was more opportunities during the summers and 8 winters than there were in the other months of the year. 9 Q And what was your understanding based on? Why 10 did you think that, Mr. Gates, if that is a simpler 11 question? I am not trying to confuse you, I just want to 12 know, you said you had an understanding that it was better 13 in the summers or winters and/or more opportunities in 14 summers and winters. I am asking you if you can recall, 15 where did you get that information from? 16 A I understand the question. 17 Q Okay. 18 A It was my understanding at the time that there 19 were more participants in the market or more demand in the 20 marketplace because of the weather, and that weather events 21 such as the warmth of a summer or the cold of a winter 22 would create more opportunities for investors in the 23 market. 24 Q Because there was greater demand for 25 electricity, is that your assumption, in those -- for 123 1 air-conditioning or for heat as opposed to the more 2 temperate months; is that the understanding that you had or 3 how, the process you went through in making sense of that 4 proposition that it was better, you had more opportunities 5 in summer and winter? 6 A Greater demand, more volume, additional 7 participants, concepts like that. 8 Q In talking about the Up To Congestion investment 9 opportunity were there people that you spoke with outside 10 of the folks involved in Huntrise Energy Fund about 11 opportunities in that particular marketplace? 12 A I have a vague recollection of talking to money 13 managers who had experience with various trades in the 14 energy markets that came to our office who were talking to 15 us about potential relationships. I believe those, some of 16 those individuals may have described this investment 17 strategy. 18 Q Other than the, your brother and the other 19 partners in Huntrise and the people that may have come to 20 your office, did you do any independent research, go out 21 and talk to folks whose opinions you thought might be valid 22 on this issue? 23 A No. 24 Q In the next paragraph Kevin writes, the strategy 25 has more capacity and we should scale up. What strategy is 124 1 he referring to, what was your understanding at the time 2 and do you have a different understanding today? 3 A At the time I have no recollection of reviewing 4 this document. 5 Q Okay. What is your understanding today, if you 6 have one? 7 A I assume the strategy that Kevin was describing, 8 in the fourth paragraph is the strategy that Alan was 9 employing for us at the time, which is, could be summarized 10 as being the Up To Congestion trade or a transaction that 11 received transmission loss credits. 12 Q And by the way, when you and Kevin Gates have 13 spoken since the investigation started about documents or 14 about issues, you say that you had spoken to him prior to 15 this deposition, is this a document that you, that the two 16 of you discussed, I am talking about Exhibit 2? 17 A Yes. 18 Q And can you relate that discussion, please, as 19 best you can recall it? 20 A It has been a while since I discussed it with 21 him, but my general recollection was that he described this 22 document as one which the Commission was interested in. It 23 was one, a document which he described had its own internal 24 conflicting statements, and it was a document that he 25 described as being one that was sent out a couple months 125 1 before we lost huge sums of money. 2 Q And what was the context in which he made those 3 statements? Were you asking him, how did he make those 4 statements about this document -- that is not a clear 5 question, let me rephrase it. 6 Do you recall where you were when you were 7 talking about the document, were you in the same room, was 8 the document in front of you? 9 A I don't recall. 10 Q Do you recall at all the context in which -- 11 first of all, how long ago was it that you spoke with him 12 about this document? 13 A I would guess that we talked about the document 14 within three months after a deposition that he had that 15 described this document, when he was presented with this 16 document. 17 Q So I take it then, were you discussing his 18 deposition and the kinds of questions that were asked of 19 him? 20 A My recollection is that he made me aware that 21 this document was one that was of interest to the 22 Commission. 23 Q And do you have an understanding as to why he 24 made you aware of this particular document? 25 A I think he made me aware of this particular 126 1 document because it was of particular interest to the 2 Commission. 3 Q And had there been any indication that you might 4 be called for a deposition at the time you were having this 5 conversation? 6 A No. We were very, very surprised when I was 7 called for a deposition. 8 Q And were there other documents that the two of 9 you discussed at the time you discussed Exhibit 2? 10 A I don't recall the specific conversation that I 11 had with him when we discussed this document, but since his 12 depositions we have discussed summary data that he has 13 provided describing gains and/or losses from our 14 transactions broken out by various income streams. 15 Q Did Kevin ever describe to you -- strike that. 16 During the time that Huntrise and Powhatan had 17 an active relationship with Alan Chen, a trading 18 relationship, did Kevin ever express to you any concerns 19 about Alan Chen's honesty? 20 A No. 21 Q Veracity, truthfulness? 22 A How is that different than honesty? 23 Q I am not sure that it is, just generally 24 accurate in reporting things, his general honesty as an 25 honest person -- let me strike that. 127 1 When you say that you were never told anything 2 that suggested that he suspected anything about his 3 honesty, you include veracity in that, that he regarded 4 Alan Chen as a person who was being truthful with him, not 5 misleading him intentionally? 6 A I do, but maybe I have a -- don't understand the 7 term veracity. To me they seem to be synonyms. 8 Q Okay, we have your answer. And in this recent 9 conversation, not the recent conversation -- the 10 conversations you are describing since Kevin Gates' 11 deposition, where you discussed Exhibit 2, did he in that 12 conversation say anything negative about his views on 13 Mr. Chen's or Dr. Chen's honesty? 14 A No. 15 Q You said that Kevin mentioned that this document 16 has conflicting statements in it; do you recall what those 17 were? 18 A I believe that Kevin may have pointed out the 19 language on page five that describes a new risk free trade 20 in the box pointing to the bar on the chart, all the way to 21 the right, and my general recollection is that he made me 22 aware that this was an area of interest to the Commission, 23 that language. And my general recollection is that he 24 pointed out the language on page three that contradicts the 25 language on page five. 128 1 Q And the language on page three that you are 2 referring to, is that the language where it says he, 3 referring to Alan Chen, describes as almost a risk free way 4 to make money as opposed to what is on page five where it 5 is said in quotes, "Alan has found a new risk free trade?" 6 A Correct. 7 Q And so the difference is the almost? 8 A Correct. 9 Q And did Kevin indicate to you whether he 10 regarded that as a particularly important distinction 11 between "almost risk free" and "risk free" in quotes, the 12 two formulations, was that one that he emphasized as being 13 particularly important? 14 A My recollection is not that he thought that 15 there was a difference between the two from a, from our 16 position, in other words I am not, I have no recollection 17 that he said risk free trade is bad and we want to stay 18 away from that, that my recollection is that he thought it 19 was unfair to focus in on one part of the document as 20 opposed to another, rather, it is more that he thought that 21 the Commission should review the document and all of the 22 communication as a whole instead of focusing in on language 23 in one box in the middle of the document. 24 Q So he assumed from the questions that were asked 25 of him at his deposition that there was that focus, 129 1 particular focus on that language risk free as opposed to 2 almost risk free? 3 A My recollection is that he was surprised that 4 one area was being evaluated very carefully, whereas, other 5 information and facts seemed to have been dismissed. 6 Q The document does say in its entirety that Alan 7 Chen was taking on, as it says here, it says he is not -- 8 isn't taking much more risk, that was -- but is increasing 9 his exposure in the marketplace? 10 MR. McSWAIN: Where are you reading from? 11 BY MR. TABACKMAN: 12 Q I am sorry, let's back up. Page three of the 13 document, Exhibit 2, it says, recently Alan's exposure has 14 significantly ramped up. Did you have an understanding of 15 what the term ramped up meant in this context? 16 Let me put it to you, do you understand that to 17 mean that the size of his investment, his activity in the 18 marketplace, the dollars that he was involved in his 19 trading had increased? 20 A Yes. 21 Q And significantly, did that indicate to you that 22 it was more than just a small amount? 23 A Of course, that is the way I define 24 significantly, the same way that I assume you do. However, 25 I am not sure that the ramping up that described here, that 130 1 it is any different sort of increasing exposure than Alan 2 did at other periods of time regarding to summers or 3 winters. 4 Q You don't know one way or the other; is that 5 correct? 6 A When I read this document it is saying that he 7 has significantly ramped up, I assume that Kevin might have 8 said the same thing in November 2009. I think that was the 9 general practice for Alan Chen, and all investment 10 advisors, that when they see opportunities in the 11 marketplace to produce better risk adjusted returns, that 12 they increase exposure. 13 Q This document, taken as a whole when you read 14 it, this document talks about a new opportunity that Kevin 15 is making you aware of, and that he has been made aware of; 16 isn't that right, isn't that what the thrust of this 17 document is? 18 A Again, I will restate, that I don't believe, 19 necessarily believe that I was aware of it at this time. 20 So when you said that he was making me aware of it, that 21 contradicts my feeling that I thought, that I am not even 22 sure I read this document, but at this point in time as I 23 sit here today, the general thought is that the way I 24 interpret this document as a whole and not to cherry pick 25 certain language and focus in areas that contradict other 131 1 areas, I would describe this document as one in which Kevin 2 is rather excited about the opportunities with our 3 investment with Alan Chen because of changes that were made 4 in the marketplace for either transmission loss credits or 5 the Up To Congestion trade. 6 Q Either/or, transmission loss credits or the Up 7 To Congestion trades? 8 A I don't understand exactly how they are related 9 to each other, but I have the sense that they are. 10 Q Well, let's look at page two. And I am not 11 talking about, again, when I ask you these questions, just 12 so you understand, I take it that, and accept that, you 13 have no particular recollection of focusing on this 14 document. 15 My question was, and just to make it clear, this 16 is a document that Kevin wrote to his business partners; 17 correct, Rich Gates, Eric Newman, Larry Eiben, Chao Chen? 18 A It was a document that he sent to the investors 19 of Huntrise Energy or Powhatan. 20 Q Is that different than saying his business 21 partners? 22 A It seems different to me, but I think we both 23 understand the relationship that we had to Kevin. 24 Q And he says right on the cover page, he 25 describes it that in summary it says -- strike that. 132 1 As an FYI, I have put together a presentation 2 describing the situation with Alan. In summary, it is too 3 exciting and we need to have a lot of exposure this summer. 4 Did I read that correctly? 5 A I think you did. 6 Q And that Larry, that is a reference to Larry 7 Eiben? 8 A I assume that is who he is referencing. 9 Q And Kevin are working on creating a new 10 partnership that we can each invest directly in and hope to 11 have set up before the summer months, parentheses (which 12 are typically profitable) close parentheses. Let me know 13 if you have questions; did I read that correctly? 14 A I believe you did. 15 Q Why did you need a new partnership, why is Kevin 16 raising the possibility of a new partnership as opposed to 17 Huntrise doing this through Huntrise Energy Fund? 18 A I think the objective of a new partnership was 19 to protect us in the case that this investment did not 20 perform well. I think Kevin was probably, and Larry, were 21 probably very worried about the potential losses for this 22 investment strategy. 23 We have -- as an investor you have a lot of -- 24 as an investor with experience, you realize that there are 25 certain events in an investment that make them less 133 1 attractive than what they appear to be on paper, and by 2 consolidated this investment into a separate partnership, 3 if this investment performed very poorly, which I believe 4 it did in late spring or early summer of 2010, that it 5 would not affect other investments or transactions that 6 were made elsewhere. 7 Q Can you turn to page two, and again the second 8 paragraph, and I will read the beginning, "PJM just changed 9 things, such that UTC traders receive Transmission Loss 10 Credits. Basically UTC traders don't have to pay 11 transmission losses anymore." Close of quote. 12 You said before you thought it was possible that 13 he might have written a document like this one at some 14 earlier date to describe the ramping up of the summer or 15 winter. This indicates, does it not, to you, that the 16 reason for this ramping up was related to, that PJM had 17 just done something new that Alan -- was causing Alan to 18 check his investments or to ramp up his investments? 19 A I am not sure that I have any recollection that 20 Kevin wrote any other document talking about the idea of 21 increasing exposure leading into either winter or summer 22 periods, however, I have the general recollection that he 23 communicated that information us somehow, either via e-mail 24 or other communication, and I think it is very possible 25 that he always had an explanation of why we should ramp up. 134 1 It could have been -- for example, we talked about earlier 2 about the decrease in fees with Alan, that he constantly 3 negotiated his agreement with Alan that defined our 4 relationship, and it is very possible that he came to me 5 and said, Rich, I just got a 30/70 fee split so this is 6 additional justification for increasing our exposure with 7 Alan. 8 Q Do you have any recollection of that happening 9 or is this pure speculation that it might have happened? 10 A I have a general sense that Kevin constantly 11 negotiated the agreement with Alan, and that fees were an 12 important part of that relationship. I also have a general 13 sense that Kevin constantly negotiated the exposure that 14 Alan was providing to us and that Kevin would -- that it 15 would be very reasonable and almost expected that he would 16 negotiate fees down as business volume increased. 17 Q You said that he constantly renegotiated the 18 fees or the terms. I would represent to you that I am 19 aware of a contract with Alan Chen in May of 2008 and 20 another one in May of 2010. Are you aware of any other 21 contracts that changed the terms of the relationship, the 22 financial terms under which Alan traded? 23 A I am not aware of any other advisory agreements 24 that were created that defined our relationship. 25 Q Going back to the second paragraph on page two, 135 1 Kevin then writes after the sentences I read before. "This 2 creates more opportunities for Alan. But, Alan is fearful 3 that PJM could change its mind and could force UTC traders 4 to pay TLC's. He hasn't heard anything to suggest that 5 they will, but I think he feels that way because it is just 6 too easy for him to make money now." Close quote, did I 7 read that correctly? 8 A I believe you did. Well, period close quotes, I 9 don't see the close quotes, but -- 10 Q I am just saying that I stopped reading there. 11 There is no quote there. I stopped, that is the end of the 12 paragraph I just read where I said period; is that right? 13 A I believe so. 14 Q And did that fearfulness of what PJM might do 15 contribute to the thought of creating a new partnership? 16 A I have no recollection that that was part of the 17 decision. 18 (R. Gates Exhibit 3 identified.) 19 BY MR. TABACKMAN: 20 Q If you would look over Exhibit 3 and let me know 21 when you have finished reading. 22 MR. McSWAIN: He wants to know when you are 23 ready. 24 THE WITNESS: I am ready. 25 BY MR. TABACKMAN: 136 1 Q Okay. Exhibit 3 appears to be an e-mail from 2 you to Kevin Gates with copies to Eric Newman, Larry Eiben 3 and Chao Chen, dated Saturday March 20, 2010, and the 4 subject is Re: Ramping up with Alan Chen. 5 There is also at the bottom and going on to the 6 next page -- I am sorry, the Bates number is POW00006998 7 and 7999. Does the e-mail that also appears as the cover 8 e-mail to Exhibit 2, and suggests that your e-mail is in 9 response to Exhibit 2, which was sent out by Kevin Gates on 10 Friday, March 19th, the day before your e-mail; is that 11 accurate? 12 A I believe we are looking at the same document. 13 Q And it states my thoughts; is that correct? 14 These are the thoughts that you had at the time? 15 A These are some of the thoughts that I had at 16 that time. 17 Q Were these the most important of the thoughts 18 that you had at the time, is that why you chose to put them 19 down, these that appear here in the document, as opposed to 20 other thoughts? 21 A I doubt that were my most important thoughts. 22 The reason for describing three thoughts or different 23 concepts, which it appears to be in my e-mail, were the 24 most important thoughts that I had at that time regarding 25 this investment. However -- 137 1 Q That is what I was referring to by your most 2 important thoughts, not your most important thoughts in 3 your entire life. 4 A I understand, but I don't think that they were 5 my most important thoughts even about this investment at 6 that time. They were probably the most important thoughts 7 that I had when writing this e-mail that I wanted to 8 express to Kevin, Eric, Larry and Chao. 9 Q But they weren't the most important thoughts 10 that you had about this topic at that time, but they were 11 the most important thoughts at the time that you wrote the 12 e-mail? 13 A They were the most important thoughts that I 14 wanted to express to Kevin, Eric, Larry and Chao at that 15 time, however, I don't believe that they were the most 16 important thoughts that I had about this investment. If I 17 were to speculate, the most important thoughts on this 18 investment at that time, I believe that my concern of it 19 being a high risk speculative investment would be near or 20 at the top of my list of the most important thoughts. 21 I also had many other thoughts about this 22 investment that I described in prior e-mail communications 23 and/or other communications I had with my business partners 24 about this, however, these three thoughts or ideas 25 expressed in this e-mail were probably either new thoughts 138 1 that I thought were worth expressing that I hadn't 2 expressed in the past, thoughts that are based on recent 3 information that I received, or other things that I felt 4 were relevant to express to my partners at that time, but I 5 don't believe that they were the most important thoughts 6 that I had about this investment at that time. 7 Q In any event these were the three thoughts that 8 you put down in response to the e-mail and presentation 9 that you received from your brother the day before? 10 A Absolutely. 11 Q And number one, what is PSP? 12 A Profit sharing plan. 13 Q So the first paragraph talks about the 14 possibility of putting tax deferred money, using tax 15 deferred money as part of your investment with Alan Chen, 16 raises the possibility of the consideration that you might 17 want to think if that is going to be a possibility; is that 18 right? 19 A Correct. 20 Q Second paragraph reads, and it has No. Two, I 21 would make sure our agreement with Alan covers us in the 22 case that we are retroactively charged a fee so that we can 23 then go after Alan and ask him for our money back. 24 Is that a reference to what Kevin had reported 25 to you in Exhibit 2 on page two of that document where he 139 1 expresses Alan's fearfulness that PJM may change its mind? 2 A I don't recall what I meant with the word fee at 3 that time. As I have stated earlier, I don't have even a 4 recollection of reading that document. However, I think it 5 is very possible that that is a type of fee that I could 6 have been thinking about. 7 Q Well, it says -- have you ever been 8 retroactively charged fees in your accounts by, in your 9 investments? 10 A Yes. 11 Q And in what context? 12 A In a stock lending relationship. 13 Q Would you describe that? 14 A Our firm was borrowing stocks to sell short in 15 the marketplace, and the brokerage firm retroactively 16 adjusted their fee for the borrowing costs. In fact, it 17 happened twice that I am aware of as I sit here today, 18 right now. 19 Q And are you suggesting that that is what you 20 were thinking about and not the possibility that your 21 brother raised in his e-mail, that PJM may try to 22 retroactively raise the fees? 23 A I think both are possibilities, or more 24 generally I think I was very cognizant of the fact that 25 things could change and you could end up with the situation 140 1 where Alan was paid a percentage of the profits and on 2 profits that were later in dispute. 3 Q Mr. Gates, weren't you concerned, weren't you 4 responding to the concern that your brother expressed that 5 PJM may at some point try to come after this money, and if 6 you paid Alan a profit, based on the profits, it is going 7 to be a shortfall to you guys; isn't that what you your 8 concern is in the second paragraph, and you want to make 9 sure that you have the ability to go after Alan if that 10 happens? 11 A I was concerned that either a marketplace or 12 some entity would charge us a fee or adjust our performance 13 in a way that made it so that we overpaid Alan. 14 Q And if you had overpaid Alan on his UTC 15 investments, weren't you, wasn't this paragraph responding 16 to the concern that PJM may change its mind about paying 17 these Transmission Loss Credits as your brother had raised 18 in Exhibit 2 the night before? Are you suggesting that 19 your response is to something other than that, sir? 20 A I am, and I have suggested that several times, 21 including several statements that I have made that I am not 22 even sure that I opened up or reviewed this document. I 23 think I am aware that I read Kevin's text of his e-mail 24 where he mentioned that things were looking very good. I 25 have no recollection of reviewing this document at that 141 1 time. 2 I was very aware at that time of seeing a 3 situation where we had fees retroactively charged to us and 4 ending up spending money on attorneys and other matters to 5 have those fees reimbursed to our account. And I was also 6 very aware that the performance period of an investment 7 advisor, the shorter that period is to determine the 8 performance fee, the more advantageous it is to the 9 advisor. In other words, if you pay let's say 50 percent 10 of profits to an advisor over a quarterly basis, that is 11 more advantageous to the advisor than if the investor was 12 paying 50 percent of profits over the course of one year. 13 BY MR. OWENS: 14 Q Are you aware of the contractual arrangements 15 that you had with Alan Chen, in terms of the timing of when 16 you would pay him his profits, his share of the profits? 17 A I have no specific recollection of that part of 18 the agreement, how it is defined. I wasn't even aware that 19 we had only two investment advisory contracts that defined 20 our relationship, which I now assume is the case. However, 21 I had this general recollection that it was a shorter time 22 period. If I were to speculate I would say on a quarterly 23 basis we paid Alan Chen his performance fees. And the 24 shorter the time period the more at risk the investor is to 25 paying money that either is lost subsequently in, as a 142 1 result of performance, or an event like the one that I ran 2 into with stock lending, where fees were charged 3 retroactively. 4 Q Have you ever had a relationship with, to the 5 best of your knowledge, with a manager in which you paid 6 them a portion of their fees quarterly with a true-up at 7 the end of the year? 8 A Can you restate the question? 9 Q Have you ever had a relationship, to the best of 10 your knowledge, with an advisor such as Alan Chen, in which 11 there was a profit sharing arrangement, and you paid them a 12 portion of their profits, the shared profits, on a 13 quarterly basis and the balance was trued up on an annual 14 basis? 15 A No, I am not aware of any such agreement that 16 exists. I have never even heard of that concept. However, 17 I am familiar with it because that is the way that our firm 18 compensates employees and owners, where on a quarterly 19 basis we are compensated based on estimates, and then at 20 the ends of the year you might get more money or have 21 money -- have your salary or compensation go to zero if the 22 estimates were too high earlier. 23 So I think I understand the concept, but I am 24 not aware of any relationship that we had with an advisor 25 that was in such a manner, and I am not aware of any 143 1 relationship that exists anywhere. 2 BY MR. TABACKMAN: 3 Q So you would be surprised to learn then that in 4 fact Alan Chen received partial payments of his total share 5 on a quarterly basis and then at the end of the year that 6 was reconciled? 7 A Yes, that would surprise me. I wouldn't 8 understand how you could make quarterly payments, how that 9 would be described in an advisory contract. I can't 10 imagine, I have a hard time as I sit here today just 11 thinking about this concept for a couple minutes, how an 12 attorney would be able to describe such a relationship to 13 make both sides comfortable. 14 Q You had said before, when Mr. Owens was asking 15 you some questions, that you don't have a particular 16 recollection of writing this e-mail and what you were 17 thinking at the time you wrote paragraph two. 18 Today, looking at paragraph two of Exhibit 3, to 19 which reference is making sure the agreement with Alan 20 covers us in the case that we are retroactively charged a 21 fee. In light of Exhibit 2 and your brother's raising 22 Alan's, the possibility Alan's concern that PJM may try to 23 collect TLC's that you had been paid, can you today say 24 that what you were thinking about when you wrote paragraph 25 two on Exhibit 3 was there concern that is in Exhibit 2, on 144 1 page two? 2 A I think it is possible that that concept of 3 having a changing marketplace that worried Alan Chen led me 4 to believe that the marketplace could change again and fees 5 could, of some sort could be charged, but I don't see the 6 word fee anywhere in this executive summary. And I haven't 7 gone through the whole document in detail, but I don't have 8 a recollection of seeing the word fee anywhere this in this 9 agreement. 10 When we were charged stock lending fees 11 retroactively I was acutely aware of the situation that an 12 investor or money manager could get into that causes a lot 13 of undue legal expenses and to a money manager, and that it 14 is better to get everything defined up front. In other 15 words, in my relationship with these two brokers it would 16 have been very nice if it said, you will not retroactively 17 charge us a fee, so that my communications would have, and 18 our efforts would have been a lot less to get the monies 19 refunded to our account. 20 Q And has that event happened at any time 21 proximate to March 29 of 2010, that would you have been 22 thinking about that, this retroactivity on the short sale 23 on the morning of March 20th? 24 A I believe both events occurred prior to that 25 point in time. 145 1 Q How much prior? 2 A I don't recall. 3 Q Was there a longer period of time between those 4 events and your writing this e-mail on March 20th, and the 5 receipt of your brother's presentation and e-mail the day 6 before you wrote the March 20th e-mail? Do you follow my 7 question or would you like me to -- 8 A Could you restate it, please? 9 Q You have described some other events in your 10 business life in which you were retroactively charged fees; 11 is that correct? 12 A Correct. 13 Q And you raised that as a possibility as to what 14 you were thinking when, might have been in your mind when 15 you wrote paragraph two on Exhibit 3? 16 A Correct. 17 Q And I am asking you now, those events, with that 18 retroactive fee charging, had they occurred longer before 19 March -- was there more time that had passed before writing 20 this March 20 e-mail than a day, had they occurred on the 21 previous day? 22 MR. McSWAIN: You are asking him when they 23 occurred? 24 BY MR. TABACKMAN: 25 Q I am asking him if there is -- I will start 146 1 over. 2 Your brother's e-mail, which raises the 3 possibility of being retroactively asked for money from PJM 4 whether it is a fee or not, was one day before you wrote 5 the e-mail on March 20th. This event with the short 6 sellers, had that occurred in between the receipt of your 7 brothers e-mail and your response receive e-mail, or had it 8 occurred sometime longer before that? 9 A I think I understand the question now, and I 10 will restate to it make sure I got it right, in different 11 language. Kevin sent his e-mail out at 5:07 on a Friday 12 afternoon. I responded at 10:34 on Saturday evening. I 13 believe that you are asking me the question of did these 14 events where I was retroactively charged a fee, did they 15 occur between Friday, March 19th at 5:07 in the evening 16 until Saturday at 10:34 in the evening. 17 Q That is exactly what I am asking. I will amend 18 the question and I will accept that question, and I would 19 like your answer to it. 20 A Well, I would like to continue. I believe the 21 answer is no, primarily because it is a very short window 22 of time in my events of my career, and also it covers a 23 period of time when the markets and businesses are 24 generally closed. However, I will take the opportunity to 25 describe another thing, a time when I was, retroactive fees 147 1 affected my business, and that was a relationship where we 2 were the investment advisor and our client accounts were 3 charged fees that were unexpected after accounts had been 4 closed down. So I was made acutely aware of the idea that 5 those fees needed to be reimbursed. 6 Q Let me just, if I may, those prior experiences 7 made you aware while you were reading this memorandum from 8 your brother that in fact the kind of thing that Alan was 9 concerned about, retroactive charging of money after you 10 thought the deal was closed, was something that could 11 happen; isn't that right? 12 MR. McSWAIN: I think that misstates his 13 testimony, because he said he didn't necessarily read it at 14 the time. 15 BY MR. TABACKMAN: 16 Q Today, as you look at this, the proximity in 17 time, and if you want to give me the proximity in time, 18 suggests to me, I will tell you that paragraph two of your 19 responsive e-mail in Exhibit 3 is responding to the concern 20 that your brother related in his e-mail and presentation, 21 that is what it appears to be. And you are suggesting, you 22 suggest that there was something else that you could have 23 been thinking about. 24 And so I am asking you now, is it possible then 25 that those other things made you even more aware in reading 148 1 Kevin's, as you read Kevin's e-mail to you, that this sort 2 of thing happens, that it is a real possibility of getting, 3 of PJM coming back at some future date and asking you for 4 money after you have already calculated Alan's profits on 5 money that you thought you were going to be able to keep? 6 A I am aware that that is what you believe, 7 because you have asked the similar or identical question 8 several times, so I understand the position, and I 9 understand why you could think that. I will restate the 10 idea that I am very aware of relationships and issues in 11 the past in my life, business work where fees were 12 retroactively charged, and it is important to have a very 13 clear document defining relationships on performance fees. 14 I have also stated several times that I have no 15 recollection of actually reviewing this document at that 16 time. And I have said that today, I said it yesterday, I 17 believe, and the only new concept I had today or only other 18 additional thing I will restate is that the word fee, I 19 don't see it in this executive summary or elsewhere. The 20 idea of having a short window of time where you compensate 21 advisors is also something that I was aware of, continue to 22 be aware of that concept that shorter windows are more 23 favorable to investment advisors, and I am also aware that 24 when there are big dollars being passed back and forth, 25 being made, being lost, if it is a very, very volatile 149 1 investment, high risk speculative investment, that 2 investment advisors have much more incentive to narrow the 3 performance window. 4 There are speculative investments that I believe 5 exist where the performance window is five years or longer, 6 and if we are compensating someone on a quarterly basis it 7 is -- I am acutely aware of the potential conflicts of 8 interest. 9 BY MR. OWENS: 10 Q So if I understand your testimony correctly 11 today, your concern about retroactive fees is a general one 12 that, based on your experience in your professional life, 13 that you have been charged retroactive fees in the past so 14 this is a general concern that you have with your 15 investments; is that true or false? 16 A I would say it is false. I wrote this e-mail 17 over two years ago, and I have no distinct recollection of 18 writing this e-mail, so I am only speculating what I was 19 thinking at that time when I describe these other sort of 20 events. When I read it today I am suggesting that either 21 the uncertainty that it is possible that I opened this 22 document and I did read it thoroughly and that I was aware 23 that changing market events could cause uncertainty in our 24 relationship with Alan, but I am also suggesting that it is 25 very possible that I was thinking of other issues that 150 1 could have caused a fee to be retroactively charged. 2 Q So if this is a concern that comes up from your 3 experience, hypothetically, then surely that is something 4 that you had raised in most or all of your investments, you 5 would discuss the possibility of, and your worries about, 6 your anxieties about retroactive fees in all of the 7 different investments that you make? 8 A There are two characteristics that I defined 9 earlier that would cause me to be more concerned about a 10 retroactive fee. That is a very volatile investment that 11 has made a lot of money or lost a lot of money, so in other 12 words if Alan made us a lot money during some pay period 13 and we paid him very handsomely for those services, 14 30 percent, 40 percent, 50 percent, whatever our fee 15 arrangement was, and then if we were retroactively charged 16 a fee or had investment losses, to me it is more a bigger 17 risk, it potentially would be more a cause for concern. 18 Also our exposure or dollars, the bigger the transaction, 19 the more I am worried about such a relationship. 20 Q So if we were to subpoena your other records we 21 would find you expressing similar concerns with funds such 22 as what you describe outside of this energy context, we 23 would find a number of these documents? 24 A I didn't say that. 25 MR. TABACKMAN: Let's move on. 151 1 MR. McSWAIN: Yeah, we are getting kind of 2 bogged down. 3 BY MR. TABACKMAN: 4 Q Paragraph three reads, of Exhibit 3, I am glad 5 we have spent a pile of money on top notch lawyers to make 6 sure this new partnership is separate and distinct from 7 everything else that we have done, and to protect us in 8 other ways with this investment. Have I read that 9 correctly? 10 A I believe you have. 11 Q And did you, do you recall consulting with 12 lawyers about this particular investment and setting up 13 there new partnership? 14 A I believe that -- no, I have no recollection of 15 talking to attorneys about this. 16 Q Do you know whether anybody else spoke to 17 attorneys about setting up this partnership? 18 A At this time, when I wrote this e-mail I 19 apparently did, was under the impression that we had worked 20 with attorneys to set up the partnership to establish this, 21 and help manage the relationship. 22 Q Do you know whether or not there was even a 23 partnership established, this new partnership, at the time 24 that you were writing this? 25 A Could you restate the question? 152 1 Q Do you know whether or not there was actually a 2 new separate partnership in existence at the time that you 3 wrote this e-mail, March 20, 2010? 4 A At that -- when I read this third point, at this 5 time I have no recollection. I can't interpret my thoughts 6 at that time whether the partnership had been set up or not 7 as of March 20th. 8 Q And when you said and to protect us in other 9 ways with this investment; what does that mean? 10 A It could be helping us manage the relationship 11 with Alan through the negotiation of an advisory contract. 12 Which, incidentally, he showed ability to negotiate other 13 investments that we have had, if the advisor does not have 14 the ability to negotiate, does not manage a separate 15 account as opposed to an investment partnership, we don't 16 have the ability to ask for changes to cover us in case 17 fees are retroactively charged. 18 Q By the way, if paragraph two of this document, 19 where it says charged a fee, if it read, asked for him to 20 return, retroactively asked for money, or charged money by 21 PJM, would that be closer to what Kevin is talking about? 22 A I don't see anything in Kevin's document to 23 discuss retroactive fee charges. 24 Q Okay. Let's move on, we have your testimony. 25 Do you know whether Kevin Gates or anybody else 153 1 associated with Huntrise Energy Fund or Powhatan Energy 2 Fund ever spoke with lawyers prior to setting up the 3 partnership about the legitimacy of trading to acquire the 4 TLC's? 5 MR. McSWAIN: I give you the same admonition I 6 have given you a couple times about not revealing 7 privileged information, keeping in that in mind you may 8 answer the question. 9 BY MR. TABACKMAN: 10 Q I am asking you the question, do you know if 11 anybody inquired at the time, back in 2010? 12 MR. McSWAIN: Did you know at the time. 13 THE WITNESS: I don't have a recollection. 14 BY MR. TABACKMAN: 15 Q Has anyone told you that they consulted with 16 lawyers, without saying what they asked lawyers or what 17 lawyers said, that they went to a lawyer at the time to 18 raise the question of trading to acquire the Transmission 19 Loss Credits? 20 A Could you restate the question, please? 21 Q Did anyone tell you that they had gone and 22 spoken to a lawyer about the legitimacy of trading to 23 acquire Transmission Loss Credits? 24 A The reason for my confusion is I don't 25 understand how this is different than the prior question. 154 1 Q I am asking you at the time. I asked you before 2 if you did, I am asking you did anyone tell you that they 3 did, that they did, some other person other than yourself? 4 A Well, maybe, my confusion is, the answer is I 5 don't recall, which would be the same. I think I 6 misinterpreted the prior question because I thought you 7 were asking me in that question whether I was aware that 8 anyone at Powhatan or Huntrise had done the same. But 9 whether you are talking about me individually, whether I 10 talked to attorneys or whether I was aware that others 11 talked to attorneys, the way I would summarize it is that I 12 did not talk to attorneys about any investment strategy in 13 the power market, and I am not aware of any of my fellow 14 investors or managers of Powhatan or Huntrise Energy who 15 talked to attorneys at that time about this event. 16 MR. TABACKMAN: Do you want to take a break? 17 MR. McSWAIN: Yes. 18 (10:06 a.m. -- recess -- 10:21 a.m.) 19 BY MR. TABACKMAN: 20 Q Okay, we are back on the record. 21 By the way, did you, Mr. Gates, did you speak 22 with your brother Kevin last night? 23 A I did. 24 Q What did you speak about? 25 A We spoke about -- I assume in relation to my day 155 1 yesterday? 2 Q Well, if you spoke about, yes, in relation to 3 your day yesterday, did you speak to him about anything 4 touching on any of the subjects having to do with this 5 investigation, your deposition, documents, anything at all 6 that is related to this investigation? 7 A Nothing of substance. 8 Q What does that mean, sir? 9 A I told him about my, such things as my arrival 10 time, when we started, who was present at the deposition, 11 where I sat at the table, my interactions with my attorney, 12 and things like, of that nature. 13 Q You didn't talk about the questions you were 14 asked? 15 A None of the substantive questions. 16 Q You mean none of the questions that I asked you 17 or Mr. Owens asked you during the course of the day 18 yesterday? 19 A We did discuss briefly the question that 20 Mr. Owens asked me about if I was aware that Enron traders 21 or Enron executives were in prison because of their 22 involvement in the power market. 23 Q Thank you. Nothing else, though, about your 24 deposition of substance or about the investigation? 25 A Nothing about the questions. 156 1 Q And nothing about the documents you were shown? 2 A Correct. 3 Q If we could have this document marked as Exhibit 4 4, please. 5 (R. Gates Exhibit 4 identified.) 6 BY MR. TABACKMAN: 7 Q If you would look at that, please, and let me 8 know when you have finished reading it. 9 A I have read the document. 10 Q The document bears, your copy of it with the 11 exhibit sticker on it has the at the bottom Bates number 12 POW00016599 and a second page I believe 165 -- 16600. Is 13 there are there any additional pages that bare page 14 numbers? 15 A Yes. 16 Q What is the last Bates number? 17 A 16601 are the last five digits. 18 Q So it is a three-page document that you have in 19 front of you? 20 A Correct. 21 Q And at the top of the first page it shows that 22 it has an e-mail from Kevin Gates to Alan Chen dated 23 March 5, 2010, and the time at 9:40 p.m.; is that correct? 24 A Correct. 25 Q And below that there is an e-mail from Alan Chen 157 1 to Kevin Gates dated March 5, 2010, at 9:37; do you see 2 that? 3 A Yes. 4 Q Would you please read that e-mail, beginning 5 with the words, Hi, Kevin? 6 A Hi, Kevin, before and in January 2010 I didn't 7 specifically target for TLC. Starting in February 2010, I 8 kicked up a notch targeting for TLC. In March 2010 I added 9 some more. Without TLC I would not touch some of the 10 trades and/or would not put in large volumes for some of 11 the trades, but with TLC as is, they are suddenly becoming 12 risk free, open parentheses (almost to the point) close 13 parentheses, trades. I will take down a little bit 14 starting tomorrow knowing that we are leaving a lot of 15 money on the table. Thanks, Alan Chen. 16 Q Were you aware in March of 2010, or between 17 March of 2010 and May of 2010, that Alan Chen was targeting 18 for TLC in his trades and that quote, or that he, quote, 19 "Would not touch some of the trades and/or would not put in 20 large volumes for some of the trades but with the TLC as is 21 they are suddenly becoming risk free almost to the point 22 trades; did you know that he was doing that? 23 A I don't recall specifically my knowledge during 24 that period of time of Alan's investment strategy, but at 25 some point during the investments I was aware that he was 158 1 targeting some sort of incentive or changing his market 2 behavior by some sort of incentive that was being offered 3 to him. 4 Q How did you become aware of that? 5 A I don't recall. 6 Q When you had spoken with your brother prior to 7 this deposition, have you ever discussed with him the 8 substance of the e-mails that appear here in Exhibit 9 Number 4? 10 A I don't believe we have ever talked about this 11 e-mail exchange or this dialogue specifically, but we have 12 talked about the general idea of altering an investment 13 strategy based on incentives offered in the marketplace, 14 which I think is the substance of this exchange. 15 Q And I believe you stated before that you regard 16 that as entirely appropriate thing to do? 17 A Logical and rational and appropriate and legal, 18 yes. 19 Q Do you know whether or not anyone associated 20 with the Huntrise Energy Fund or the Powhatan Energy Fund 21 in, at the time between March and August of 2010 inquired 22 as to the legality of trades that were quote "targeting for 23 TLC?" 24 A I don't have any specific knowledge of that. 25 However, I am certain that if we ever thought for a second 159 1 that there was a problem or inappropriate behavior that 2 would result in any issues with the regulatory body or 3 anyone else that we would have pursued them, any issues 4 vigorously. 5 Q Are you aware of risk free trades that you have 6 ever engaged in, or ones that you would describe to a 7 person whose money you are investing as risk free, almost 8 to the point? 9 A I have described efforts by an estate attorney 10 who I have worked with for risk ways that to me are 11 bulletproof ways to avoid paying estate taxes. There are 12 certain trusts and other arrangements that can be set up 13 such that you don't pay estate taxes. 14 In terms of risk free transactions in the 15 marketplace, I think they are opportunities that we don't 16 actively seek because they are impossible or almost 17 impossible to define or to find, but to say that I have 18 never described a transaction that we have done as risk 19 free would not be fair. If there are times when I 20 evaluated investment strategy and it looked very profitable 21 or exciting, it produces excellent risk adjusted returns, 22 during a moment of over exuberance I may have described 23 something as risk free. 24 Q You say that you regarded the UTC market as a 25 high risk investment; is that correct? 160 1 A I define my investments with Alan Chen as a high 2 risk investment. The numbers seemed to go up a lot 3 sometimes and go down a lot other times. 4 Q Have you examined the numbers, the profitability 5 of your investment with Alan Chen, you yourself, in the 6 months of May, June and July of 2010? 7 A I am aware that those were profitable months 8 overall for me in the fund, and for the fund as a whole, 9 and I am aware that I was a relatively large investor in 10 the fund. 11 Q I will ask the question again. Have you 12 personally examined the records and looked at the 13 profitability, see the profitability of the fund in dollars 14 and cents for the months that I designated, May, June and 15 July? 16 A I don't recall ever having done so. 17 Q Have you ever looked at the profitability of the 18 trades Alan Chen made on behalf of Powhatan Energy Fund for 19 the months of May, June and July 2010, and determined where 20 the profits came from, what the source of the profits were; 21 have you ever done that? I think that is a yes-or-no 22 question. 23 A I have not reviewed the underlying trades of 24 Alan Chen to try to determine where the money came from. 25 Q Have you seen summaries of the trades that Alan 161 1 Chen made on behalf of Powhatan Energy Fund in those months 2 that show the profitability of those trades in dollars and 3 cents? I have asked before if you looked at the trades and 4 to focus on that. Have you seen summaries that describe 5 where the source of profitability was? 6 A Yes. 7 Q When was that? 8 A I don't recall specifically. I would guess 9 sometime in the -- in the first six months after Kevin's 10 first deposition. 11 Q And what did you discover when you looked at 12 those? 13 A My recollection of that, my review, is that the 14 Transmission Loss Credits were a substantial part of the 15 income stream for Powhatan. 16 Q Did you discover -- did you discover in looking 17 at summaries that in fact, but for the Transmission Loss 18 Credits the trades would have been unprofitable, would have 19 been losses? 20 A In aggregate for that quarter? 21 Q Yes. 22 A That is my recollection, in aggregate the 23 Transmission Loss Credits exceeded the total income, net 24 income to our fund. 25 Q What is your recollection of the amount by which 162 1 the total, the Transmission Loss Credits, roughly exceeded, 2 I forget the term you just used -- 3 A Income stream? 4 Q Yes. 5 A I don't recall, but I know that it was 6 substantial. 7 Q In excess of a million dollars? 8 A I don't recall. 9 Q Did you, have you ever seen a summary that 10 described the daily trades or any document that described 11 how Mr. Chen structures his trades on behalf of the 12 Powhatan Energy Fund during that period, or at least the 13 vast bulk of them? 14 A I don't believe so. 15 Q Has anyone ever told you that Dr. Chen set up 16 trades on a daily basis where he would, on the course of a 17 day, 24 hours, put in bids for all 24 hours and wind up 18 sending 40,000 megawatts of electricity from one node to 19 another, over the course of the day in excess of 1000 an 20 hour, while at the same time sending 1000 -- 40,000 21 megawatts from one of those nodes back to the original 22 node, have you ever seen that, anything that showed that? 23 A Nothing -- no, not that specifically, but I was 24 very aware that he was doing trades that would hedge out 25 certain risks while obtaining, while seeking out the 163 1 incentives that the marketplace offered. 2 Q In fact, weren't you made aware that for a large 3 majority of the trades, well, for a substantial number of 4 the trades that he made on a daily basis during the period 5 I have described, there was, it was impossible to make any 6 money on the spread, the price spread between the two 7 nodes? 8 A I am not aware that he entered into transactions 9 knowing whether he would make money on the quote -- the 10 spread as you have described it or the Transmission Loss 11 Credits. I think in hindsight you can evaluate the 12 transactions that took place and come up with a description 13 such as substantial or significant to describe the number 14 of transactions were, lost money on one part of the 15 transaction but made money on other parts. 16 But I my understanding is that at that point in 17 time when the trades were placed he did not know whether 18 they would make money or lose money. 19 Q And is it your understanding that he did not 20 know whether a trade from point A to point B of a certain 21 number of megawatts of electricity, at the same time then 22 sending that same number during that same hour from point B 23 to point A, you don't know whether he understood whether he 24 was going to make any money on the spread, just on the 25 spread? 164 1 MR. McSWAIN: Are you asking him what he knew at 2 the time or just what he knows now? 3 BY MR. TABACKMAN: 4 Q I am asking him if anyone had ever, if he has 5 ever looked at anything that has shown him that or has 6 anyone ever told him that Dr. Chen could not make any money 7 off of trades like the one I described? 8 MR. McSWAIN: That is the same question. You 9 can try to answer it. 10 BY MR. TABACKMAN: 11 Q I am not interested in whether he thought he was 12 going to make money off the TLC, whether he knew, you said 13 it was impossible to predict whether it was going to be 14 profitable, and I am asking you whether anybody has told 15 you or you have ever seen any documents that show trades 16 like I have described, and whether or not he could have 17 made any profits off of the spread in prices between point 18 A and point B? 19 A During this period of time prior to the 20 investigation I had no idea, nowhere close to this level of 21 understanding of the investments that Alan was making. 22 Subsequent to the beginning of the investigation I have 23 learned information that leads me to believe that Alan did 24 not even, did not know whether he would make money on 25 spreads that when he bought at as you described point A 165 1 with the intention of selling at point B, that he would not 2 even know what the price at point B would be or whether 3 even these trades were accepted, that there was a lot of 4 uncertainty in all aspects of it at the time, but I have a 5 low -- you know, I still -- I don't have a lot of 6 confidence in that explanation, but that is my general 7 understanding. 8 Q And this general understanding of the 9 uncertainty that you have just described, where does that 10 come from, who has told you that, how have you come to that 11 knowledge? 12 A I read one of the documents that our attorneys 13 submitted describing our position, and my guess is it was 14 somehow articulated within that document. 15 Q Have you read Dr. Tabors' affidavit? 16 A I don't recall. 17 Q Have you spoken with Dr. Tabors? 18 A No. 19 Q Has anyone from the Powhatan who has been an 20 investor of Powhatan Energy Fund ever spoken, to your 21 knowledge ever spoken with Dr. Tabors? 22 A I don't know. 23 Q Do you know, has anyone told you what the 24 substance of Dr. Tabors' affidavit contains, since it has 25 been filed with the Commission it is not a privileged 166 1 document? 2 A I am aware, I know, I am aware that we have 3 various experts who are describing our case. I believe the 4 one, I believe there is someone in D.C., Wallace, the 5 attorney that worked on the -- used to work for FINRA, that 6 I believe I -- I believe it is not Tabors, I believe it is 7 somebody else, and I have a recollection of reviewing that 8 material briefly because it is something that I understand 9 coming from the equity world, but I don't believe that is 10 Tabors. 11 Q That is Mr. -- your recollection is correct, 12 there is a Mr. Wallace, Richard Wallace, used to be with 13 FINRA and the SEC, and he has a written a document. 14 Dr. Tabors, I believe can be described as an 15 economist, generally works up in Boston, has been 16 associated with MIT, a consultant, and has written another 17 affidavit giving his opinions of Dr. Chen's trades. Have 18 you ever -- has anyone described to you the substance of 19 Dr. Tabors' affidavit? 20 A I don't know. 21 Q You have heard the name Dr. Tabors before? 22 A Yes. 23 Q And have you -- in what context? 24 A In relation to this case. 25 Q And how did you hear that name? 167 1 A Maybe with discussions with my attorney, maybe 2 with the review of paperwork or responses that have been 3 submitted to the Commission, I don't recall specifically. 4 Q But you don't recall -- do you recall reading a 5 document that discussed the rationale for Dr. Chen's trades 6 written by a consultant? 7 A I -- not specifically, I recall reading, I 8 believe I read Wallace's documents and I presume that he 9 also, you could also describe his opinion, my recollection 10 is that you may be able to describe his opinion as one 11 coming from an expert to describe the rationale for Alan's 12 trades, but I do not recall specifically anything coming 13 from reviewing anything from Dr. Tabors. 14 Q And do you know whether Dr. Tabors' opinion was 15 that Mr. Chen or Dr. Chen engaged in spread trades based 16 upon, in all instances for Powhatan Energy Fund? 17 A I don't know. 18 Q Have you talked with your brother about the 19 opinion of the expert from Boston? 20 A I don't recall. I do remember hearing somebody 21 from I thought Harvard, but maybe I mixed it up and it was 22 MIT, but they are both kind of prestigious universities up 23 in that area. So I do have a recollection of Kevin saying 24 there is somebody from Harvard, but maybe I misheard, but, 25 you know, that could be Dr. Tabors. 168 1 Q And I might be misrecollecting, he may have an 2 association with Harvard or MIT. It stuck in my mind MIT, 3 but it may have been both. In any event, what do you 4 recall your brother telling about this guy from Harvard? 5 A My vague recollection is that he was happy to 6 have experts supporting our case, describing our case, and 7 even supporting Alan. 8 Q And did he describe -- in what ways did this 9 expert support Alan and your trades? 10 A He supported it because he has, it is my vague 11 understanding, that he is a very smart, had experienced, 12 considered a very impressive expert, credible, and that 13 somehow he described the transaction, that all of our 14 experts that we are using are describing our transactions 15 as being very legitimate and legal. 16 Q If you had known in May, June, July of 2010 that 17 Alan Chen was making trades that were unprofitable, set up 18 to be unprofitable, and that would have costs associated 19 with them, and that the only profitability was from this, 20 what you have used before, rebate; would that have 21 concerned you? 22 MR. McSWAIN: Is that a hypothetical or are you 23 portraying that as a fact? 24 BY MR. TABACKMAN: 25 Q I think it is a fact, but you know, we can do it 169 1 as either way. I mean, would that have concerned you if 2 you had known that there were trades where the only 3 profitability came from the TLC, the rebate? 4 A I don't know that it is fact because, as I 5 mentioned earlier, when Alan entered into these 6 transactions I don't believe that he knew each individual 7 transaction, whether the spread would be profitable or the 8 TLC credits would be made available to him at the end. 9 So I, my limited understanding of these 10 transactions at this point in time is different than your 11 opinion that he entered into these transactions knowing 12 that they would be unprofitable. I think there was a lot 13 of uncertainty with each transaction. 14 Q Have you ever discussed with your brother his 15 view having now or at the time in 2010, his view as to 16 whether or not many of the trades that Dr. Chen set up were 17 going, were automatically unprofitable except for the TLC? 18 A At the time we did not talk about it. 19 Subsequent to the start of the investigation we have talked 20 about playing Monday morning quarterback, when you can look 21 back at the transactions and see where the gains and losses 22 came from. We have talked about the idea that when you 23 enter into transactions you don't know where the gains or 24 losses will come from, and we have talked about the general 25 sense that during this period of time, one portion of the 170 1 investment strategy kind of, you know, did most of, 2 generated most of the income, more than 100 percent of the 3 income. 4 (Discussion off the record.) 5 (R. Gates Exhibit 5 identified.) 6 BY MR. TABACKMAN: 7 Q Let me know when you are finished reading it. 8 MR. McSWAIN: Do you want him to read the entire 9 thing? 10 THE WITNESS: I have scanned it so I am ready to 11 go. 12 BY MR. TABACKMAN: 13 Q Exhibit 5 bears POW00016942, and the last number 14 is 16947; is that correct, the document you are looking at? 15 A Correct. 16 Q And it is an e-mail chain or thread, I forget 17 the word? 18 A Correct. 19 Q And the top one on the first page is from your 20 brother Kevin Gates to Alan Chen, Sunday, March 7th, 2010, 21 is that right? 22 A Correct. 23 Q Below that is one from Alan Chen to your brother 24 Kevin Gates on Friday, March 5, 2010, at 9:51; is that 25 correct? 171 1 A Correct, I think we are looking at the same 2 document. 3 Q And this one reads, and I will read it, Hi, 4 Kevin, The volumes have been increased pretty significantly 5 but the risks associated with the trades overall are 6 actually lower than before. Most of the added volumes came 7 from correlated pairs that produce a few cents for tens of 8 cents up-side with almost no down-side risk. Without TLC, 9 the transaction costs would absorb them and deem them 10 unprofitable. Did I read that correctly? 11 A Yes. 12 Q Were you aware that Dr. Chen was engaged in 13 trades, were you aware in 2010 at anytime between March and 14 July of 2010, that Dr. Chen was making any trades, making 15 trades that can be described as without TLC the transaction 16 costs would absorb them and deem them unprofitable? 17 A No, I was not aware. 18 Q Is that something that you would have expected 19 your brother to tell you as part of his management 20 responsibility with respect to Alan Chen? 21 A No. 22 Q You would not have expected him to tell you 23 that? 24 A That is correct. 25 Q Looking at the next paragraph in that same 172 1 e-mail, from my past experience, a few hundred megawatts, 2 like 400 megawatts, for a pair would likely cause 3 performance degradation so I generally take 400 megawatts 4 max; did I read that correctly? 5 A Yes, I believe so. 6 Q Did you ever have a discussion with anyone 7 between March and July of 2010, about the impact of volumes 8 of megawatts on performance degradation? 9 A I don't remember specific conversations about 10 that but I was aware of what I would describe of capacity 11 restraints in his strategy. 12 Q How did you become aware of that? 13 A I don't recall. 14 Q What are the possibilities? 15 A It is possible that it was described to me in an 16 e-mail, it is possible it was described over the telephone 17 in a conversation that I could have had with some of the 18 fellow investors in Powhatan, it is possible it would be 19 described, the idea would be described to me orally. 20 Q And do you have, can you say when it is possible 21 that you had one of those contacts that would have imparted 22 that information to you? 23 A I would assume that it have happened before we 24 even made an investment with Alan. 25 Q Why do you assume that? 173 1 A Because it is very standard to talk about, you 2 have the concepts of capacity or how much money can be 3 invested in a strategy, is one that I am very familiar 4 with. 5 Q What was your understanding with respect to this 6 strategy that Dr. Chen was engaged in? 7 A That he had, like all other advisors, he had 8 limited ability to manage money, limited -- there is a 9 limited number of dollars that he could manage. 10 Q In this instance when he was talking about 400 11 megawatts for a pair would likely cause performance 12 degradation, do you understand that now, based on whatever 13 conversations or e-mail you may have read or other 14 communications, that he is referring to the amount of 15 electricity that he can send between two locations without, 16 you know, that there is a maximum that will then -- that if 17 he exceeds could result in less of a return on the 18 investment? 19 A That is my general understanding of what I think 20 he was trying to, the point he was trying to make with that 21 paragraph. 22 Q And in any records that you have seen since, at 23 any time up until today, have you ever seen what mega 24 wattage Dr. Chen was trading between nodes, locations on 25 behalf of Powhatan Energy Fund on an hourly basis, whether 174 1 his -- I am sorry, let me just make it clear, whether he 2 exceeded on a regular basis 400 megawatts? 3 A I don't recall and I am not even aware that 4 megawatts is a unit that is describing the amount of size 5 of the trades that would take place. 6 Q Did -- if you look at the e-mail, the first, the 7 e-mail at the top of the page, did you ever discuss with 8 your brother at the time or subsequent to these trades 9 being made, what he understood to be the capacity for these 10 trades on behalf of Powhatan Energy Fund? 11 A At that time I don't -- I don't have any 12 specific recollections of the capacity at any time during 13 the relationship. My vague recollection is that the 14 capacity was a moving target related to the time of the 15 year, the investment strategy that was Alan was employing, 16 and the -- or a relationship that was negotiated on fees 17 and trades, the size of our investments relative to Alan's 18 account. 19 Q Have you ever discussed with anyone how Dr. Chen 20 was, any strategies he had that allowed him to increase the 21 volume of mega wattage without increasing the risk of loss? 22 A I don't have any specific recollection of having 23 those conversations, but I am aware that during periods of 24 time when he was increasing his exposure that it is 25 possible to have higher exposure in a strategy, in one 175 1 strategy, and lower risk return characteristics than a 2 separate strategy. So it is very possible that that was 3 described to me and it seemed to make a lot of sense. 4 Q Did anyone ever tell you at the time, that is 5 the period between March and July or August 2010, or 6 subsequently, that the way that Dr. Chen managed to 7 increase volume, that one of the ways he was able to 8 increase his volume of trades, was by sending the same mega 9 wattage of electricity from point A to point B, and then 10 simultaneously from point B to point A, so that they would 11 negate each other? 12 A I don't believe so. 13 Q If you had known at the time that he was doing 14 that for that purpose, would that have concerned you? 15 A Can you define that purpose? 16 Q For the purpose, yes, for the purpose of 17 negating the risk of sending a higher volume by simply just 18 having it go in both directions simultaneously from A to B 19 and B to A, so that the mega wattage at least, the flow as 20 they say in electricity terms, netted out to zero between 21 the two nodes; would that have concerned you? 22 A No, it wouldn't have, and the reason is it is 23 something that makes intuitive sense to me, that it is 24 possible to do transactions that are just, that are there 25 to hedge out a return of an investment strategy that over 176 1 the long haul don't expect to make money. 2 For example, the TFS Market Neutral Fund, which 3 was the 40 Act mutual fund that we described yesterday, is 4 a longs/shorts product registered with the SEC that has 5 approximately $1.7 billion in assets in it, it was launched 6 in 2004, is a whole portfolio of over a billion dollars 7 that is designed to hedge out the returns of the fund, to 8 lower volatility, which means lowering risk, and the longs 9 portfolio in that strategy or in other words one portion of 10 that portfolio, is designed to, in what we in our industry 11 call adding alpha, or actually making money. 12 The shorts, well, the shorts can I guess produce 13 alpha as well, so I will backtrack a little bit, but the 14 longs are the ones that will make money on an absolute 15 basis. When we starting doing shorting in that portfolio, 16 even though right now it is over a billion dollars of 17 shorts, over time I don't expect them to make money. 18 We tell investors that they are there to hedge 19 out the portfolio risk to make it less volatile, to make it 20 a more attractive investment for our investors. 21 So that concept resonates with me. So, not only 22 would I not think there was a problem, I would think that 23 Alan is doing his job. 24 Q And in the trades that you just described in the 25 equity market, do you get any rebates for the number based 177 1 on the size of the trade that you make? In this particular 2 fund that we are talking about, not hypothetically, but the 3 one that you just described? 4 A Yes. 5 Q What are those? 6 A We have relationships with our brokers now where 7 all the fees that are set by the exchanges are passed 8 through to us. So on a monthly basis we go back and we 9 look at what happened in the prior month, what their 10 expenses were or profitability on this one portion of the 11 trades, and we redefine our commission for the subsequent 12 month based on the rebates that the brokers received. 13 We also receive substantial discounts from our 14 various business partners for the size of our transactions. 15 So, in other words, we are able to negotiate lower fees 16 with our custodian, with our administrator, with our 17 executing brokers and our prime brokers as well as others, 18 I believe our auditor also recently gave us a discount 19 because of our size, because we have grown. 20 Q And do you, have you engaged in trades in that 21 fund, increased the number of trades or the size of the 22 trades that you have made solely for the purpose of gaining 23 the rebates? 24 A No. 25 Q Would that be something that you would deem 178 1 proper for you to do? 2 A Yes. 3 Q It would be proper for you to, that for no 4 economic purpose, if there were no -- if there were no 5 economic purpose other than the acquisition of the rebates, 6 would that be an appropriate trade for you to make in the 7 equities as you understand it? 8 A It is my understanding that it is appropriate, 9 and the reason that I think that is because it is described 10 in a concepts release that the SEC issued, this general 11 idea that you are offering, this hypothetical idea that you 12 are describing here I think is described in the concept 13 release the SEC issued in January of 2010, the idea that 14 traders are there for the purpose of maximizing the rebates 15 that they obtain. 16 Q And under what circumstances? 17 A If they think they can make money. 18 Q Are they market makers? 19 A I -- can you define that term? 20 Q Well, I am asking you, in the concept release 21 did the SEC say that they thought that that was entirely 22 appropriate or did they say that they were seeking opinions 23 on that practice? 24 A It is my -- well, first I don't understand the 25 term market maker as you have used it. To me they are 179 1 investors, money managers, who participate in trading in 2 the marketplace with the objective of making money. And I 3 think some have, I think casually described them as market 4 makers, but I think that is a very specific term that I 5 don't think applies to, may not apply, I don't understand, 6 I am not sure, but I don't think it may apply to all of 7 these participants. 8 But it is my understanding of the concept 9 release and other factors that I have seen, that that is a 10 very viable, legitimate, honest and good practice and 11 logical, rational practice for those participants to 12 perform. 13 BY MR. OWENS: 14 Q You say though that you have never, this fund 15 has never engaged in those types of trades, simultaneously 16 buying and selling securities in order to gain the rebate? 17 A That is correct, that is what I said. 18 Q Why not? 19 A Because it is too hard for us. We would like to 20 do it but it requires a -- a very a different skill set 21 than what our firm possesses. 22 Q What skill set does it involve? 23 A It is a very different investment practice. My 24 understanding of traders were doing that, they are kind of 25 an elite group of participants in the market, although 180 1 there is not a lot of public information describing who 2 they are, I don't know, I couldn't tell you who all the 3 traders are that participate in this incentive, my general 4 understanding that is they are kind of in a very elite 5 group with substantial resources behind them, who have a 6 lots of technical expertise, bigger staff, more money, 7 better connections to the exchanges and to New York in 8 doing practices such as co-location where they have their 9 computer servers sitting next to the exchange's computer 10 servers. 11 Q I don't understand. If you are saying that it 12 requires what in order to buy and sell securities 13 simultaneously, co-location is that -- 14 A Well, there is a couple things I think I 15 mentioned, one was more money, more resources, more 16 employees, employees with a different skill set than the 17 ones that we possess, connections to New York, the ability 18 to -- an office in New York. The advisors in West Chester, 19 Pennsylvania, I think it is impossible to effect this 20 transaction. 21 Q I am confused why you think it requires more 22 employees and more expertise, it seems to me, and granted I 23 am not an expert, I am just a lawyer, that buying and 24 selling is something traders do, and buying and selling the 25 same securities at the same time is something that anybody 181 1 could do, in fact I imagine you could write a piece of 2 software that would do it automatically for you? 3 A I disagree. 4 Q But if you had the ability to do it you would, 5 for lack of a better word, you would engage in this churn 6 trade? 7 A I would -- I think there is nothing wrong. I 8 would explore the idea. In this hypothetical question that 9 you have asked me, I would explore the idea of engaging in 10 a transaction that would be acutely aware of the rebates or 11 the incentives that the marketplace offered, in fact, I 12 think a lot of people are doing just that. 13 BY MR. TABACKMAN: 14 Q Do you have any reason to believe that PJM 15 offered the rebates for the purpose, for a purpose 16 analogous to the one that you have just described in this 17 trading? 18 A I assume that -- I don't know, but I assume that 19 is why they were there, was to encourage the type of 20 behavior that, the type of behavior like Alan's, maybe 21 other behavior that could also capture these rebates. 22 Q Why do you make that assumption, what is that 23 based on? 24 A I am assuming that PJM traded an incentive for a 25 purpose, and that traders who receive that incentive are 182 1 doing the actions that the regulator expected and wanted. 2 Q And do you have a reason to believe that the 3 regulator or the marketplace expected, wanted, traders to 4 engage in otherwise unprofitable transactions and at higher 5 volumes simply to increase the amount of Transmission Loss 6 Credits they receive? 7 A At that time I don't believe that Alan entered 8 into -- did not know whether trades would be profitable or 9 unprofitable. I believe that he did not know whether he 10 would receive credits or not receive credits. I had reason 11 to believe that if he is doing a behavior that had 12 incentived him or a venue or a marketplace has incentived 13 him to do, by providing money that he is doing what that 14 exchange wanted and expected. But in hindsight when I look 15 back, the reason why I assume that this may not necessarily 16 be the case, is because we are sitting here today. 17 Q And so it is your assumption -- let me show you, 18 let's mark this as exhibit. 19 (R. Gates Exhibit 6 identified.) 20 BY MR. TABACKMAN: 21 Q Let me know when you have finished? 22 A I have finished. 23 Q Exhibit 6 does not bear a Bates number, it is 24 probably because of the way I printed it out, it was I 25 believe part of, I know it was part of the production from 183 1 Powhatan. Have you ever seen this document before? 2 A I don't believe so. 3 Q If you would look at the handwriting, the 4 printing and the writing that appears on page 2 of 9, page 5 4 of 9, page 6 of 9, does that appear to be the handwriting 6 of your brother Kevin? 7 A I believe it is. 8 Q Do you have any knowledge as to how Powhatan 9 would have obtained this document? 10 A No. 11 Q Have you heard of a location in the course of 12 your involvement as an investor or in this investigation, a 13 place referred to as COMED, is that a place that you have 14 heard? I am not asking you whether you know where it is, 15 but whether you have heard that -- 16 A It is possible, and I would guess New York, 17 New York region is something that comes to mind, so I have 18 heard of COMED, I think I have heard of COMED. I have 19 definitely heard of MISO, I have definitely heard of PJM. 20 Q If you look at page one you see up at the top it 21 says, Four Load Forecast Regions, and number one is COMED, 22 and it shows a place on the map where the number one is? 23 A Yes, and I no longer think it is new York. 24 Q Right, it is in the Chicago region, area, and I 25 would represent to you it is part of PJM. Somewhat of a 184 1 like hypothetical question, but do you see near where the 2 2 is just to the left, the location Dayton? 3 A Yes. 4 Q Now, both of those locations are in PJM. I 5 would represent to you that MISO is in, the location for 6 that node, is in Indianapolis, okay? 7 If I traded, I sent 1000 megawatts of 8 electricity from Dayton to MISO, and 1000 megawatts of 9 electricity simultaneously from MISO to Dayton, is there 10 any way, given what you know of how these things are 11 priced, that somebody is going to make money just on the 12 difference in price? 13 A It is my understanding that you can make or lose 14 money on the difference in price and you don't know going 15 into the transaction what the result will be. 16 Q And you can make money on the difference in 17 price sending it from one location to another, and from 18 that other location back to the same one at the same time; 19 is that your understanding? 20 A Yes, it is my understanding, what I described 21 earlier, that the price when you buy at a certain location 22 and sell at a subsequent location, that the price that you 23 sell at is not known by the time that you make the 24 purchase. 25 Q I understand. And then when you initially sell, 185 1 if you simultaneously sell, simultaneously sell at the 2 location where you, or send that same amount, just reverse 3 that transaction, does it make any difference whether you 4 know what your price is going to be at the second location? 5 Let me rephrase that. 6 My hypothetical said from Dayton to MISO, and 7 you said, well, you don't know what your price is going to 8 be where you are going to sell it; did I understand your 9 testimony correctly? 10 A Yes. 11 Q And at the same moment you buy at MISO, you have 12 sold into MISO, you buy it right back and send it on to 13 Dayton, does it make any difference if you know what the 14 prices are going to be at the two locations if price 15 doesn't change on that kind of instantaneous basis? 16 A It is my understanding that in this example 17 there is four prices that you need to be aware of, the 18 purchase price in Dayton, the sale price in Indianapolis; 19 the purchase price in Indianapolis and the sale price in 20 Dayton. It is my understanding that the two sale prices 21 are unknown and, therefore, you are not guaranteed 22 anything. And it is my understanding that you are not 23 even, you don't even know whether the transaction will be 24 effected, which is different concept to me than the 25 equities world, because when I enter an order to buy 186 1 Microsoft at market order, I know my buy is going to take 2 place. So it is my understanding, one thing I have learned 3 is that this is a different in that you don't know whether 4 your trade will even go through, and if it does go through 5 you don't even know what price it will, what the sale price 6 will be, and that latter point is something that I am 7 familiar with because if I do a market order for Microsoft 8 I don't know what I will buy or sell it at. 9 Q Do you have any reason, based on anything you 10 have heard in this case, do you have any reason to believe 11 that the sale price at MISO, on that side, is different 12 than the buy price at MISO at the same moment? 13 A I assume -- I don't know -- I haven't been -- I 14 don't know this level of detail definitely at the time, the 15 summer of 2010, at this point in time I would say that I 16 think the buy price at one location and the sale price 17 could be two different numbers. 18 Q What do you base that on? Well, let me ask you 19 this. Is it based on your experience as an equities 20 trader, is it based on something you have heard about 21 buying and selling of electricity, or is it some other 22 basis? 23 A It is based on all of those things. 24 Q And with respect to the buying and selling of 25 electricity, what is, what have you heard about that leads 187 1 to you believe that the buy price at a location at a 2 particular moment in time is different than the sale price 3 at that same location at that same moment in time? 4 A Just the general concept that there, you don't 5 know whether monies were going to be made or lost with 6 these transactions, that you don't know whether you are 7 going to buy low and sell high or buy high and sell low. I 8 don't believe I have had a specific conversation about this 9 level of detail about buy and sell prices at Dayton, you 10 know, a price A and price D, you know, that I have provided 11 four prices earlier, the first to buy is Dayton and then 12 the subsequent sale at Dayton, I don't think I have ever 13 had any degree of -- this level of discussion about those 14 two prices. 15 Q Is that something that would you have expected 16 Alan Chen to know? 17 A Whether the prices would be the same? 18 Q Right, I mean how the pricing structure works, 19 whether or not the buy price at Philadelphia, Pennsylvania 20 at 11:27 is going to be different than the sale price, 21 would you expect Alan Chen, as your trader, to know that, 22 whether the prices change that frequently or not? 23 A I don't know enough about his trading strategy 24 to say that he would or should know that information. I 25 don't understand enough about nodes and the overall 188 1 marketplace to even render an opinion. I can suggest that 2 he would be a better person to talk to than I would be, 3 though. 4 Q But I am trying to understand what your 5 understanding was, and since you have offered an opinion on 6 these trades. Now, if I understand you, you are saying you 7 don't know whether the person that you engaged to invest 8 your money would know how the marketplace, the process in 9 the marketplace for pricing, buying and selling at a 10 particular location, takes, you know, occurs? 11 A My uncertainty is based on the idea that I 12 realize how complex markets places can be. I do equity 13 trading and I realize that there are dozens of a different 14 venues and marketplaces, and each venue and marketplace has 15 its own rules and regulations related to priority, related 16 to rebates, related to queues, so I can envision a scenario 17 where an investor could say, Rich, you don't even 18 understand such and such a point or fact about a certain 19 marketplace or structure in a venue. 20 And even though I realize that it is not, may 21 not be important or a high leverage item, the piece of 22 knowledge that would have a material impact on my 23 investment strategy, that I don't know, that I don't want 24 to pass judgment on what Alan could have or should have 25 known. I do know that he was an expert. I do know that he 189 1 is highly trained and has a lot of, had a lot of 2 work-related experience. 3 Q And were you aware that he had engaged in 4 extensive research in the area of these trades over a 5 number of years and set up models that, I haven't asked yet 6 but I believe that these are the ones that he developed, 7 but let's just say that he developed ones like that? 8 MR. McSWAIN: Which ones are you -- 9 BY MR. TABACKMAN: 10 Q I am sorry on page 6 of 9? 11 MR. McSWAIN: You are saying these are Alan's 12 models on page 6 of 9. 13 BY MR. TABACKMAN: 14 Q Right. I believe the entire document is. I 15 haven't asked Dr. Chen that. I will represent that he has 16 described documents that appears, looks like this one, and 17 I had not found it at the time that I was speaking with 18 him, but I believe, I know that he has divided PJM into 19 four regions and done models. 20 Would you have expected him to have done that 21 kind of historical work to know how the system operates, 22 not what the precise prices were, but how pricing occurs? 23 A I would expect him to develop models. I would 24 expect him to have a general sense of how the market 25 structure was set up. 190 1 BY MR. OWENS: 2 Q Mr. Gates, if I represented to you that the buy 3 and sell price at particular nodes is the same in a given 4 hour, and if you take that as a given, and if I were to 5 trade from A to B and B to A simultaneously in equal 6 amounts, is there a way for me to make money? 7 MR. TABACKMAN: On a spread. 8 MR. McSWAIN: Are you assuming in your 9 hypothetical that both legs of the trade are guaranteed to 10 clear? 11 BY MR. OWENS: 12 Q Yes. 13 A In this hypothetical example where you have two 14 different locations and you are guaranteed that both legs, 15 both orders will be filled completely, in other words the 16 way I think of it, if I want to buy 1000 shares of 17 Microsoft and short 1000 shares of IBM, that I am 18 guaranteed both of those transactions will take place. I 19 assume that is when we talk about both legs being accepted, 20 that is that concept that the orders will get filled, and 21 that we know that the pricing will be identical at certain 22 locations, Dayton and Indianapolis, I think were the two, 23 assuming there were no other incentives or income steams 24 and that was the whole hypothetical, then I would say no. 25 Q And if you add had to that fact an additional 191 1 fact that every trade contains transaction costs, and I 2 will represent to you roughly a dollar per megawatt, so if 3 you traded 1000 megawatts from A to B and 1000 megawatts 4 from B to A in the same hour, you have already said you 5 wouldn't make any money on the spread, would you agree that 6 if you engage in this trade you would in fact lose money 7 because of the, once you take the transaction costs into 8 account? 9 MR. McSWAIN: Does your hypothetical assume 10 there is no TLC? 11 BY MR. OWENS: 12 Q Yes, it does assume there is no TLC. 13 A So I will restate this hypothetical example, 14 which to my understanding has never existed in the world 15 before, is that you are buying a item in your hypothetical 16 megawatts from venue A at a price, selling at venue B at a 17 separate price, and then at the same time buying at venue B 18 at the same price it was sold at, selling at venue A at the 19 same price for the same quantity or exposure, and that 20 there is some sort of drag or commission or cost associated 21 had with it, and there is no other reason to do the trade 22 including a Transmission Loss Credit or any other 23 incentives, then in this hypothetical example that I don't 24 believe has ever existed in this, in any marketplace that I 25 know of, I think the answer is you will lose money. 192 1 BY MR. TABACKMAN: 2 Q Why do you believe that it has never existed in 3 any marketplace that you know of? 4 A I have never heard of it. 5 Q Have you ever talked with Dr. Chen? 6 A Dr. Alan Chen? 7 Q Correct. 8 A As I mentioned yesterday, I believe I had a 9 brief interaction with him one time when he came into our 10 office, but it was not related to his business practices or 11 his involvement with Huntrise Energy or Powhatan. 12 Q What is the part of that hypothetical that you 13 say you believe never existed, that makes it deviate from 14 the actuality? 15 A There is a couple things. One, all the 16 documents we have been talking about talk about are 17 Transmission Loss Credit. 18 Q Right, but we have set that aside, we are 19 setting that aside as the ultimate reason for doing the 20 trade, okay? But the hypothetical that we have talked 21 about of buying at A, selling at B, buying at B, selling at 22 A, where the buy and sell price at B is the same for both 23 sides of the transaction, it is a different than it is at 24 A, but at A it is the same for both sides of the 25 transaction; why do you believe that that has never 193 1 existed? 2 A Well, I will go back to the Transmission Loss 3 Credit, even though you seem to be dismissing it, that is 4 something that I believe was part of, an integral part of 5 the market structure. Two, we have talked about the idea I 6 think several times that there is no guarantees that the 7 trades would actually be accepted or effected in the 8 marketplace. And C, I mentioned to you earlier that I 9 wasn't even aware that the prices would be the same. 10 And I -- so that is the reason why, and I also 11 assume it never existed because you guys made it very clear 12 that this is a hypothetical question. 13 Q We started this line of inquiry I believe with 14 what would trouble you and what wouldn't trouble you, and 15 so I guess where I want to come back to is that. 16 Did you know that Dr. Chen had studied, Dr. Alan 17 Chen, had spent a number of years studying the clearing 18 prices at the various nodes that he placed trades at, 19 historical, set up models that forecasted what they would 20 be on various days of the year, various seasons, and had 21 studied that have carefully? 22 MR. McSWAIN: Are you saying, are you 23 representing that as fact. 24 BY MR. TABACKMAN: 25 Q I am representing that as fact, that he has done 194 1 that, that he has testified to that under oath, that he has 2 made those kinds of studies, part of what he did in setting 3 up his business, and placed his trades in ways that they 4 were likely, highly likely to clear. I mean have you ever 5 talked, we started off with were you aware of that, that he 6 had done that kind of modeling? 7 A At the time during the summer of 2010 and prior 8 I was made aware that he had created models or analysis to 9 help him with his trading, so that resonates with me, that 10 concept, exactly. Pricing at various nodes is something 11 that is too technical. If I were to look at this document 12 I had, when you first presented to it me I had no idea that 13 this was a model or what you described as his model. 14 Q I don't know that it is in the entirety, but one 15 of the things he has here is major city weather forecast, 16 so he is trying to see what the weather is going to be like 17 at various places. And we also have similar day patterns 18 where Dr. Chen, and again, I will represent to you, has 19 said that he has looked back historically and based his 20 trading on what the seasonality, what the weather, what has 21 happened in prior years, as one of the bases on which he 22 decides whether a node is a good import node, whether it is 23 a good export node. 24 And were you aware, does it -- well, let me ask 25 you this: Does it surprise you that as an expert trader 195 1 that he is something that he might have done, set up that 2 kind of analysis? 3 A It would surprise me if he didn't trade some 4 sorts of analysis. 5 Q And are you aware of the number of times a leg 6 was rejected, one side of that trade was rejected in the 7 months of May, June -- I am sorry, in the months of June 8 and July, after May 30th, how often one of Dr. Chen's legs 9 was rejected in this trade that we talked about from A to B 10 and B to A? 11 A I had no understanding at that time the number 12 of trades that were rejected in July of 2010, August 13 of 2010, June 2010, or any month prior. 14 Q Have you subsequently learned how many were 15 rejected during the months of June and July? 16 A I don't recall. 17 Q Has anyone ever told you, has your brother, that 18 Dr. Chen set up his trades to remove the spread, the price 19 spread between the two nodes, by having bid them in the 20 format I described, A to B and B to A, and that was his 21 purpose in doing that? 22 A Just the opposite. It was my understanding that 23 he set up trades with the expectation that he would not be 24 able to remove that part of the risk characteristics of the 25 trade. He entered into them expecting that there is a 196 1 possibility they may be rejected. 2 Q I understand that there is a possibility. Was 3 it your understanding that he set them up and structured 4 them so that that wouldn't happen, that he did everything 5 possible to set them up so that that would not happen? 6 A Just the opposite. I think he entered into the 7 agreement with the expectation that some, that he could do 8 other things to ensure that they were executed, either by 9 trading, offering a different prices or things like that. 10 Q So what -- I am sorry, I am asking you not -- my 11 question is, did you understand that Dr. Chen's goal in 12 setting up the A to B trades, and the bids that he put in, 13 that it was designed to remove the uncertainty of the price 14 spread and to reduce it as if he reduced it at one node? 15 A It is my understanding that he made efforts to 16 minimize the risk of his transactions. I don't know that 17 he did, I don't think he ever entered into these 18 transactions with the expectation that risk would be 19 removed or eliminated. 20 Q Understanding that there is no certainty in the 21 world, did anyone ever tell you that Dr. Chen entered into 22 the kinds of trades we have described, A to B, B to A, same 23 volume, same time, and set those up with, by making bids 24 that where he was reasonably certain that one wouldn't 25 clear? 197 1 A I don't know about what reasonably certain is, 2 if I can make that -- 3 Q I will amend the question, I will amend it to 4 say, where it was his desire and his goal to try to 5 effectuate that outcome, where one leg would not clear? 6 A I -- as I mentioned earlier, I was made aware or 7 generally aware that since the investigation began that he 8 was, made efforts to minimize the risk of that outcome. 9 Q And do you know what steps he took to minimize 10 the risks of that outcome? 11 A No. 12 Q Do you know, has anyone told you what caused him 13 to develop a structure of trades that would minimize that 14 outcome, if there was an event, a particular event that he 15 was responding to in restructuring his trades? 16 A When I spent the time in reviewing the documents 17 that Kevin sent out in March 2010, it sounds like my guess 18 that at this time is that he restructured his trades based 19 on the changing marketplace and the incentives that were 20 offered. 21 Q Let's come back to where we started. Would it 22 trouble you if, would it have troubled you in 2010 if you 23 understood that the only, let's not accept quite the 24 hypothetical, that the only way that one could make money 25 off of particular trades was the Transmission Loss Credit, 198 1 and that was his goal to do that, to target the 2 Transmission Loss Credits, the rebate, would that have 3 troubled you, or at least caused you to inquire further, as 4 to the legitimacy of his trades? 5 MR. McSWAIN: Would that hypothetical trouble 6 him; right? You are not asking him to accept that as fact? 7 BY MR. TABACKMAN: 8 Q Well, what I am trying to avoid is the fight, 9 you know, the possibility -- 10 MR. McSWAIN: We can disagree about what the 11 actual facts are, but -- 12 MR. TABACKMAN: Yeah, on that hypothetical? 13 MR. McSWAIN: Okay. You can answer that. 14 THE WITNESS: I can provide the same answer. I 15 think I have been asked the same question before is my only 16 cause for pause, and I can describe the TFS Market Neutral 17 Fund, and the longs portfolio that is designed to make 18 money, the shorts portfolio that I expect not to make money 19 but hedge out the risk, I can describe that in more detail 20 if you would like, and other examples that are very 21 similar. 22 BY MR. TABACKMAN: 23 Q You regard that situation as analogous to Dr. 24 Chen's trades? 25 A Yes. The concept of entering into transactions 199 1 to minimize risk, lower volatility to improve risk adjusted 2 return, is one without, with the objective of -- with the 3 expectation that it will make money is one that I am very, 4 very familiar with and have been for a long time. 5 Q How about with the expectation that it will lose 6 lots of money? 7 A Yes, I have a short, the TFS Market Neutral Fund 8 has a short in the S&P 500 today, I entered into that 9 transaction with the expectation it will lose lots of 10 money. 11 Q And do you have an expectation that 12 simultaneously you will make enough money off of a rebate 13 from someplace that will not only overcome all of the 14 losses that you have incurred on that trade, but will turn 15 it into a highly profitable trade? 16 A I have -- there are investments in the portfolio 17 that I expect will generate gains that will more than 18 offset the losses from that transaction. 19 Q I am talking about -- yes, I understand that, 20 and I am asking you, within that transaction is there 21 another income stream that causes you to engage in that 22 money-losing transaction because as part of the 23 transaction, not some other transaction, part of that 24 transaction it turns it into a money gainer? 25 A Yes. 200 1 Q You engage, you have that experience? 2 A I have that experience. Maybe I am losing -- we 3 are not communicating properly, but I will articulate my 4 thoughts more clearly, and if we seem to have 5 miscommunication you can pose another question to me. But 6 right now the TFS Market Neutral Fund is short the S&P 500 7 or a product that mimics the S&P 500 but less expensive, it 8 is my expectation that that transaction will lose money, 9 lose substantial money, and the reason I feel that is 10 because over time the S&P generally appreciates in value. 11 There is another transaction that we, the fund 12 has entered into whose, that will generate an income stream 13 that I think will more than offset the losses that the fund 14 is incurring, that I expect the fund may incur with the 15 shorts on the S&P 500, such that the overall investment 16 will be one that is desirable to our investors. 17 So the S&P 500 there, of course is there to 18 minimize risk. We constantly evaluate our exposure to the 19 S&P 500 and do everything we can to minimize the risk. 20 Q And in your hypothetical you have two 21 transactions that are going on; is that correct? 22 A This is not a hypothetical, it is a -- 23 Q In your description? 24 A I have, will not disclose the other side of the 25 transaction, but more than one, and I have disclosed that 201 1 one of them is an S&P 500 short that I expect will lose 2 money. 3 Q And on the short, just on the facts of the 4 short, that trade itself, is there some income stream that 5 you receive as a result of making that trade that converts 6 that expectation of losing money into actual money, into 7 making it profitable, that trade alone? 8 A As I mentioned before, and I can restate it 9 maybe a little bit more clearly, we have shorted the S&P 10 500. I expect that that transaction will lose money. 11 There are other transactions that are separate and distinct 12 from the S&P 500 that I expect will generate more than 13 enough income than the S&P 500 that I expect it may lose. 14 And I enter into these transactions not knowing whether the 15 S&P 500 will make or lose money, I enter into this 16 transaction with the expect that it will, but that is okay 17 because it will minimize the overall risk of this trade or 18 strategy. 19 Q I understand. 20 BY MR. OWENS: 21 Q You say you are shorting the S&P this morning, 22 do you have an equal long position in the S&P, equal in 23 terms of volume and price? 24 A No. 25 Q Would you ever, let's take a hypothetical fund, 202 1 I don't want to talk about your trading strategies, that is 2 not what we are here for, that is with respect to your 3 activities with your mutual fund necessarily, but would you 4 ever start a fund in which you would simultaneously long 5 and short the same stock at the same price, and have that 6 represent the entirety of your fund, so 50 percent is short 7 at 10, and 50 percent is a long, you have purchased at the 8 same time, that is to say? 9 A Yes. 10 Q And would you make money on that fund if 11 everything was locked in that way? 12 A I believe there is a member of the SEC who has 13 talked about, a former professor, I believe he is from 14 Texas, I forget his name, he now works for the SEC or has 15 at some point in the last five years worked for the SEC, 16 talked about box trades where they talk about hedging out 17 exposure via derivatives or other things, with the 18 incentive for either influencing proxy battles, generating 19 soft lending income, or other things. 20 So it is something that I believe the SEC is 21 aware of, and it is something that I believe is documented, 22 specific examples, where there is transactions such as the 23 one that you described. 24 Q Right, but that -- so you are saying though that 25 that transaction wouldn't make money itself, it is making 203 1 money for some additional transaction, stock lending, proxy 2 votes, et cetera? 3 A The actual buying and the selling of the 4 derivatives or stock, yes, I don't believe it would 5 generate income, or be, have any gain, financial incentive 6 to enter into that transaction unless there was something 7 incremental. 8 Q By incremental you mean extraneous to that 9 transaction? 10 A Something additional such as a proxy battle, a 11 soft lending income, Transmission Loss Credit, something 12 like that. 13 (Discussion off the record.) 14 (11:58 a.m. -- recess -- 12:04 p.m.) 15 (R. Gates Exhibit 7 identified.) 16 BY MR. TABACKMAN: 17 Q Would you take a look at Exhibit 7 and tell me 18 when you are ready. 19 What is the last page number on that, Bates 20 number? 21 A 11503. 22 Q But is there anything other than the 23 confidentiality notice on the third page? 24 A No. Okay. 25 Q The document Exhibit 7 bears Bates number 204 1 POW00011501 to 11503; is that correct? 2 A Yes. 3 Q And on the front first page the top e-mail, that 4 is an e-mail thread; right, between your brother, Kevin 5 Gates, and Alan Chen? 6 A Correct. 7 Q And it begins, the earliest of the e-mails 8 appears to have been from Alan Chen to Kevin Gates at 11:08 9 a.m. on Wednesday, April 7th; is that correct? At least 10 that is what the document indicates on the second page, top 11 line? 12 A Yes. 13 Q And it reports here that -- have you ever seen 14 this e-mail before, to your knowledge? 15 A I don't believe so, but I can't, don't recall. 16 Q And I take it -- do you have any recollection of 17 ever discussing this particular e-mail or document with 18 your brother? 19 A I don't recall having that conversation. 20 Q The first e-mail, from Alan Chen to Kevin Gates, 21 references an attachment that was -- two attachments, one 22 is in HEEPF fund PnL statement for March 2010, and the 23 other is the HUNT2, which I will represent to you is 24 Mr. Chen's shorthand for the Huntrise Energy Fund 25 statement; is that correct, that that is what he references 205 1 here, those two attachments? 2 A That is what it appears. 3 Q Okay. And he describes in the third line, third 4 separate line or paragraph of page two, it says attached 5 please also find the March 2010 statement for HUNT2. 6 HUNT2's total monthly PnL is $372,267.68. And then he has 7 a parentheses, (equal negative $340,923.69, plus 8 $713,191.37) close parentheses; did I read that correctly? 9 A I believe so. 10 Q And through the chain he then explains to your 11 brother -- well, let's take them one at a time. The next 12 e-mail chronologically is the one from Kevin Gates at 13 11:38 a.m. on April 7; is that correct? 14 A Correct. 15 Q And he says, you know, you made a little more 16 money than you originally thought, that is nice, but I 17 thought that you were expecting about half of the money to 18 come from PnL and half from TLC. Obviously, it would have 19 been a very bad months if not for the TLC. Why was this 20 surprising and do you have any thoughts re: The TLC trade? 21 Did I read that correctly? 22 A I believe so. 23 Q And did Kevin Gates ever, at the time, at or 24 around the time of this e-mail, or since that time, express 25 to you that he was surprised to discover that the 206 1 profitability of the trades was largely dependent on the 2 TLC as it is here? 3 A I don't recall. 4 Q You don't recall if you have ever had a 5 discussion with him where he indicated that at some point 6 he was surprised to discover that? 7 A That is correct. 8 Q Have you discussed with Kevin Gates the issue of 9 the profitability of Alan Chen's trades on behalf of 10 Huntrise and Powhatan? 11 A Can you restate the question? 12 Q Have you discussed with Kevin Gates the 13 profitability of the Huntrise, the trade that Alan Chen 14 made on behalf of Huntrise and Powhatan, and specifically 15 at any time where the profit came from? 16 A Oh, Exhibit 1 that was described yesterday, is a 17 dialogue where we specifically talked about the 18 profitability. In that exchange he said, we are knocking 19 on a five bagger. Yesterday I defined what I thought he 20 meant a five bagger meant, and we talked about the language 21 where I described it as whacky good. So, that was one such 22 example where we talked -- 23 Q What is the date of that exchange? 24 A January 2009. 25 Q How about at any time after March, after the 207 1 document that is reflected in Kevin Gates' presentation to 2 you about the TLC, I believe that is Exhibit 2? 3 MR. McSWAIN: Are you talking about 4 March 2010 -- 5 BY MR. TABACKMAN: 6 Q Yes, sometime after March 2010. 7 A I presume, I have some recollection of losing a 8 large sum of money in this investment account, through my 9 investments in Powhatan, and it might have been in April 10 of 2010 after this, it might have been May, it might have 11 been June. I suspect it wasn't July or August, when the 12 profitable trades, I believe where we made large sums of 13 money, but I remember having some, a vague recollection of 14 a dialogue with Kevin about the losses and gains, because 15 it seemed to be volatile. 16 Q And did Kevin ever tell you about any steps that 17 Dr. Chen, Alan Chen, was taking to make it less volatile, 18 in an effort to make it less volatile? 19 A I don't have any -- did I have dialogue with 20 Kevin during that time period? 21 Q Yes. 22 A Prior to say September 2010? 23 Q Yes. 24 A I don't have any specific recollection of 25 actions that Alan, dialogue with Kevin about actions Alan 208 1 was doing, the specific mechanics of his investment 2 strategy, his modeling, but I have some general 3 recollection of Kevin saying that Alan was working on his 4 model, was improving, was sometimes finding opportunities 5 in the marketplace, sometimes not finding opportunities in 6 marketplace. 7 I have the general sense that we talked about 8 possibility as we were talking about summers and winters 9 and the shoulder months, I think was the term that was 10 used, where things were not, didn't present as many 11 opportunities. 12 Q Did Kevin Gates, during the period subsequent to 13 March 19th of 2010, up until now, ever tell you that one of 14 the strategies that Dr. Chen has adopted in an effort to 15 make the transactions less volatile was to send 16 electricity, with was to buy and sell electricity 17 simultaneously at two nodes and selling to the other nodes 18 at the same volume? 19 A So is the question have I become aware of it 20 since the investigation began? 21 Q That was a, that was one of the things, if not 22 the major thing that he did, to deal with this large loss 23 that you recall so clearly, and understandably, that 24 occurred in late May of 2010, right as Powhatan was 25 opening? 209 1 A I became aware of it, and I don't know whether 2 it, the idea that the transactions were -- what you are 3 describing as transactions from various nodes to each 4 other, and I don't know whether it is through my 5 conversations with Kevin or reading our responses from our 6 attorneys to the Commission. 7 Q You became aware that that is one of the things 8 he did, that Dr. Chen did? 9 A I am not sure -- well -- 10 Q I just want to make sure. You said you are not 11 aware of the source, I just want to make sure what it is 12 that you are acknowledging though that you have heard that 13 that has happened, that he did that? 14 A I am acknowledging that I am aware that he 15 traded from various locations to other locations, and with 16 a goal of minimizing the market risk. I don't know that I 17 can say that I am aware that he traded from node A to node 18 B, and then from node B to node A, or from Dayton to 19 Indianapolis, and then from Indianapolis back to Dayton, 20 but those concepts don't conflict with my understanding of 21 what he was doing. 22 Q Are you surprised, or would you have been 23 surprised in 2010, to have seen this e-mail thread that 24 describes the source of the profitability? 25 A No. To me it is exactly what this sort of 210 1 dialogue that I would expect. To me it shows that Kevin 2 did not understand what was exactly taking place. He, I 3 don't understand his last sentence of the second paragraph 4 in his e-mail dated April 7th, 2010, 11:38, but in general 5 I have a sense that Kevin is confused, he doesn't 6 understand, he doesn't get the source of the income which 7 he is trying to learn more, so that resonates with me. 8 I know that Kevin did not understand exactly 9 what was taking place, and it is also doesn't surprise me 10 at this time or even at this time that there could be one 11 source of a transaction that generated a lot of income 12 whereas another part of the transaction lost income. 13 Our shorts on the TFS Market Neutral has lost 14 millions and millions of dollars, I believe since the 15 inception of our fund, whereas our longs have generated 16 substantially more. 17 Q But as we have said, just to confirm, your 18 shorts, the short sales have not been identical to your 19 long purchases in both the exact transactions happening 20 paired up in any way; is that correct? 21 A Yes, and in the TFS Market Neutral Fund we have 22 different portfolios. Sometimes we do end up in what we 23 call box positions, but they are not intended, but they are 24 incidental. 25 Q The top e-mail on the first page where it says 211 1 Hi, Kevin, this is from Alan Chen to Kevin, in a response 2 to Kevin, saying in his 11:47 a.m. e-mail that he was 3 confused, we made seven -- he said, he identifies his 4 confusion. And Alan Chen responds, Hi, Kevin, what I am 5 trying to say is that if I didn't have to those extra 6 trades in just for TLC I would have made some money. For 7 every single TLC trade we would lose money on PnL and make 8 money on TLC so it is just shifted. If you want to talk, 9 please let me know. I'll be available this afternoon. 10 Did I read that correctly? 11 A I believe so. 12 Q The idea that he, that Alan Chen had placed 13 trades just for TLC, had you seen that in, when this was 14 written April 7 of 2010, would that have caused any concern 15 about the way he was making his trades? 16 A I don't fully understand what all Alan's points, 17 what he is trying to describe. If I was the recipient of 18 this e-mail I would pick up the phone and call him and say, 19 Alan, I don't understand what your, these two sentences 20 mean, that you begin your e-mail with. 21 But the idea that I think the general point that 22 you are trying to make is one that I think I have responded 23 to in the past, and that is no, it would not have caused 24 concern to me, I think that it would be a rational move to 25 enter into transactions with the expectation that one side, 212 1 that there is one part of the transaction would generate 2 income and another part could or may generate losses, but 3 the net effect of the investment is positive, has a 4 positive expected outcome, even though there are no 5 guarantees. 6 Q If you would have picked up, why would you have 7 picked up the phone and called Alan Chen, what would you 8 have expected him, what would you have asked him? 9 A I don't know what he means when he says extra 10 trades then just for TLC. I would ask him to explain that 11 sentence. He describes the idea that he, I have made some 12 money, I would ask him to describe the money that he would 13 have made. I would ask him to describe the difference 14 between, for every single TLC trade -- I don't understand 15 the reference that he makes to TLC trades in the second 16 sentence, how it is different than the reference that he 17 makes to trades just for TLC in the first sentence. 18 Restated, the first sentence seems to imply that 19 the TLC trades generated positive money, whereas, the 20 second sentence seems to imply that it would lose money. 21 Q Doesn't these two sentences imply that at least 22 as he is describing this, indeed the calculation that he 23 has made, shown in the statement, is that he has separated 24 out the PnL inherent in the transactions that he did from 25 the TLC, so that the spread in the transactions lost a lot 213 1 of money, but it was made up for in these Transmission Loss 2 Credits that he received? 3 A That is my general impression of this overall 4 dialogue, of this whole e-mail exchange, but I can't say 5 that I really understand Alan's communication that is on 6 the top of the document. 7 Q Assume for the sake of argument that that is as, 8 is what it appears to be, that he had set up his trades and 9 he did extra trades just for the TLC, knowing that they 10 would lose money on the spreads; would that have caused you 11 to be concerned about the legitimacy of his trading? 12 MR. McSWAIN: I think you have asked that 13 numerous times. You can repeat yourself if you have to, 14 but I mean that is why this is taking so long. 15 THE WITNESS: Would you like me to respond 16 again? 17 MR. McSWAIN: Maybe you can respond briefer. 18 BY MR. TABACKMAN: 19 Q Yeah, just briefly. Your answer is no for the 20 same reasons you have given before? 21 A No for the same reasons I have given before and 22 probably other reasons that I could describe as well. 23 Q Why was Powhatan investors looking for somebody, 24 other traders in the UTC market in the summer of 2010? 25 A I don't know, I don't recall that we were 214 1 looking for other UTC traders in the summer of 2010. I do 2 have a recollection of interviewing other traders at some 3 point in time related to this, that I believe may have been 4 related to this transaction, but in hindsight I will say, 5 it would be the common sense approach to look for other 6 traders that were able to produce investment strategies 7 that produced favorable risk adjusted returns. 8 I remember yesterday describing comparing Alan 9 Chen to the employee that worked for us, Krishna, I think 10 it was in a dialogue, an e-mail in one of the exhibits, and 11 that my recollection was that Alan Chen produced better 12 risk adjusted return, had better numbers than Krishna did, 13 so it seems to be common sense. 14 Q Let's have this marked as Exhibit 8, please. 15 (R. Gates Exhibit 8 identified.) 16 BY MR. TABACKMAN: 17 Q Mr. Gates, read that to yourself and let me know 18 when you have read it. 19 I am not going to ask you details about the 20 attachment that begins at POW00001922. We will discuss 21 everything between -- 22 A I am looking at a different document. 23 Q I am sorry, I apologize. Yes, okay. I am 24 mostly going to want to focus on the e-mails that appear on 25 pages 2438 and 2439. 215 1 A Okay. 2 Q This is a document that begins with the letters 3 POW00002438 through 2445, and it is an e-mail thread with 4 some attachments; is that correct? Looks like it is an 5 e-mail thread from among the members of the Powhatan Energy 6 Fund and then also a gentleman by the name of Bob Steele. 7 Have I accurately described it for our purposes here? 8 A I believe so. 9 Q Does this refresh your recollection about 10 considering other UTC traders in the summer of 2010? 11 A Yes. 12 Q What do you recall now? 13 A I recall that some individuals came into our 14 office and I met them and talked about a potential working 15 relationship with them. 16 Q And am I right that at least based upon what you 17 are able to see, your reaction was that their trading 18 looked good to you, said the numbers look great but wonder 19 if they backed out fees. Does that reflect a positive 20 initial response on your behalf, on your part to what you 21 saw from them? 22 A I think so. 23 Q You also had other concerns about how, things 24 that you were interested in and whether or not you needed 25 to be there; is that also fair to say? I am just trying to 216 1 summarize whether you were going to attend the meeting with 2 them or what interest that you had in information that you 3 wanted to establish or find out; is that right? 4 A I just read the paragraph, the second paragraph 5 of my e-mail dated June 25th, 2010, and it is my 6 understanding from that what you describe is somewhat 7 similar to the way I would describe it. 8 Q Did you actually meet, do you remember meeting 9 Bob Steele? 10 A I remember meeting one or more individuals, I 11 remember talking about to someone about horses. 12 Q Okay. I would like you to focus on the e-mail 13 that appears on the first page, 2438 from Chao Chen to you 14 with a copy to Kevin Gates, Larry Eiben, Eric Newman, 15 subject: Opportunity in virtual power trading, and Chao 16 Chen writes, I just read the presentation, I am not that 17 excited about it. I think UTC is just a loophole that 18 anyone knows about it can exploit. There is very little 19 skill. I wouldn't hire any of these guys to work for TFS, 20 including Alan. Did you have any conversation with Chao 21 Chen after this? 22 A I don't recall. 23 Q Have you talked with your brother about this 24 e-mail at any time since it was written up to today? 25 A I don't recall. 217 1 Q Your brother writes back to Chao Chen in the top 2 e-mail, I agree that UTC is a loophole that probably a 3 dummy can exploit. But why rule these guys off? Just 4 because they are doing UTC? They should drive a truck 5 through that loophole, even if they know how the FTRs/ICE 6 or Virtuals. That's what I would do. 7 Did you have any discussion with your brother 8 about that e-mail? 9 A I don't recall a specific discussion about this 10 e-mail thread. I do have recollections of talking to Kevin 11 about the idea of exploiting opportunities in the 12 marketplace or profiting from opportunities that are in the 13 marketplace, when they presented themselves. 14 Q Did you ask Kevin what he meant by a loophole at 15 anytime, or Chao Chen for that matter, either one of them? 16 A I don't recall asking them what they meant in 17 these specific communications, but in the past we have 18 talked about loopholes in that I would describe generally 19 as things that present opportunities to profit when others 20 may not see them. We have described things as being able 21 to create these trusts and these various structures to 22 avoid paying any estate taxes as something that we have 23 describe as a loophole. We have had numerous attorneys in 24 our office that talked about these ways to structure an 25 estate so that zero goes to the government, and to me it 218 1 was very surprising, something I did not expect, because I 2 had always heard about the death tax, and described and I 3 guess the political realm, and I was surprised to think 4 that it was purely optional. 5 We have described things in the past as the 6 limitation where certain income levels you cannot add money 7 a Roth IRA but you can add money to a traditional IRA and 8 then immediately convert it into a Roth. So by putting 9 money into a traditional IRA then it will allow to you end 10 up at your desired goal of having the monies in a Roth. 11 Eric Newman and I in the last three years I believe we went 12 to Rite Aid and with a certain set of coupons or discounts 13 or incentives, and walked out with radios that you can hang 14 in your shower with money in our pocket. In other words, 15 Rite Aid, it is my recollection, gave us this radio in 16 addition to money to, as part of the transaction. So we 17 entered with no money and just coupons and incentives, and 18 left with a radio and cash in pocket. 19 So those are the types of things that I assume 20 that these two individuals may have been thinking about 21 when they described it as a loophole. 22 Q Well, they weren't thinking about things that 23 happened after this event, after the e-mail; correct, like 24 the Rite Aid experience, they weren't thinking about those? 25 A I don't remember when we walked away with the 219 1 Rite Aid, I meant to say in the last couple of years. So 2 it is very possible that in 2009 or even 2008 for that 3 matter, that Eric and I ended up with the radios and the 4 cash. 5 Q What was your reaction when you learned that the 6 Market Monitor for PJM had contacted Alan Chen to express 7 his concerns about the large volume trades that Alan Chen 8 was putting in for Powhatan? 9 A I don't recall my specific reaction but I would 10 generally describe it as one, my recollection that it may 11 have been something that I was aware that the market 12 structure may change again, the incentives, the structure 13 of the market may cause Alan to alter his strategy once 14 again. 15 Q When you learned that the Market Monitor might 16 refer the matter to the Commission because of the large 17 volumes of trading, what was your reaction? 18 A I don't recall my specific reaction, but in 19 general I would assume that I had thoughts such as 20 happiness knowing that regulators were overseeing the 21 markets and making sure that participants were behaving 22 fairly and honestly, because that is what I expect in the 23 market. We are a heavy player in the equities markets and 24 futures markets and other markets now, so it is comforting 25 knowing that regulators were paying attention to make sure 220 1 that all participants were behaving appropriately, and 2 ethically, and I also probably had some sense that, 3 potential concern that this review or investigation may 4 become, cause problems or not, have some effect that may 5 not be overly positive. 6 Q Did the fact that Alan Chen immediately wanted 7 to decide to stop trading the large volumes, did that cause 8 you any concern in regard to his prior practice, cause you 9 any concern that he may have some doubts about what he was 10 doing? 11 A At the time I don't recall knowing that Alan 12 Chen changed his behavior once he was notified by a Market 13 Monitor or a regulator. 14 Q You don't recall being told that at some point 15 shortly after learning that there was a regulator who had 16 called him? 17 A I don't recall knowing that Alan changed his 18 trading behavior after he was notified, immediately after 19 he was notified of being contacted by a market regulator. 20 I am aware at some point in time he significantly changed 21 and/or terminated his management of our fund. 22 Q Why did he do that? 23 A I don't recall. 24 Q Did he talk with anybody about why he did that 25 since it happened? 221 1 A I don't recall specifically. 2 Q What do you recall generally? 3 A Generally that the market was changing and, 4 therefore, his investment strategy would have to change. I 5 recall knowing that he was, had a different capitalization, 6 or was concerned, very concerned about the legal expenses, 7 that he was acutely aware that an engagement with the 8 Commission could be one that could make him go bankrupt 9 even though he felt like he was, did everything legally and 10 ethically. 11 Q Where did you hear this, the fact that he was 12 concerned about the possibility of bankruptcy even though 13 had done everything ethically? 14 A I don't recall, but I presume it could have been 15 from Kevin or Larry, or maybe my counsel, I don't recall 16 specifically. 17 Q Do you recall saying well, if this, if this is 18 entirely legal, why doesn't he just continue? 19 A Yes, and I have been made aware of people who 20 are doing everything legally and ethically and run out of 21 money from an over zealous regulator. 22 Q I am talking about continuing to do the trading, 23 why didn't you argue, since you had, you knew about the 24 trading and didn't have any, don't feel that it was in any 25 way inappropriate, why didn't you argue to continue to make 222 1 these trades that were highly profitable by July of 2010? 2 A I think that would be the logical thing to do. 3 Q What would be the logical thing to do? 4 A To encourage the transactions to continue while 5 the market structure was set up in a way that made them 6 profitable. 7 Q But you didn't do that? 8 A I am sorry? 9 Q But you didn't encourage that? 10 A I don't recall. 11 Q You don't recall whether you encouraged it? 12 A That is correct. 13 Q Do you think it is a possibility that you 14 encouraged Alan Chen through your brother or someone else 15 to continue making the trades that he had been doing? 16 A I think it is possible, and I think it would be 17 the logical and rational thing to do, assuming that he knew 18 when the market, the rules are changing. In other words, 19 if the market structure incentives are altered and assuming 20 that he was kept informed and had a good handle and 21 understanding of what new rules would be enacted and when 22 they would be enacted, I think that it would be a 23 reasonable thing to do to continue to make money in this 24 transaction until the rules changed. 25 Q Do you know whether the rules changed? 223 1 A I believe they did. 2 Q How did you become aware of that? 3 A I don't recall specifically. 4 Q What do you recall generally? 5 A I recall generally that a, an event occurred 6 sometime, I believe subsequent to July or August of 2010, 7 where this incentive or structure of rebates, TLC, was 8 removed from the marketplace, it was rolled back. In other 9 words, the market structure addition that was added to the 10 market sometime in the prior months or years, had been 11 removed to make it so that the market structure as of let's 12 say October 2010, would have looked more similar to the 13 market structure that was in place in say October 2006. 14 Q And do you know what was the impact of that on 15 Dr. Chen's strategies? 16 A They changed. 17 Q How did they change? 18 A I assume that he no longer considered 19 Transmission Loss Credit as a source of income, or 20 minimized the impact that -- minimized his efforts to try 21 to obtain such credits. 22 Q Why do you assume that? 23 A Because it is my understanding that the 24 Transmission Loss Credits were central to the changes that 25 the marketplace -- that the changes that the marketplace 224 1 enacted. 2 Q And was it your understanding that obtaining 3 Transmission Loss Credits was central to Dr. Chen's 4 strategy for making profitable trades? 5 A I don't recall at that time knowing much about 6 it, whether it was central or important or what percentage 7 of income it was generating. I do know that it was an area 8 that he had been focusing on. 9 (Discussion off the record.) 10 MR. TABACKMAN: We have no further questions. 11 MR. McSWAIN: Okay. I don't have any questions. 12 MR. TABACKMAN: Thank you, Mr. Gates, for your 13 time. 14 THE WITNESS: Thank you. 15 (Whereupon, at 12:49 p.m., the deposition was 16 concluded.) 17 18 19 20 21 22 23 24 25 225 1 I HEREBY CERTIFY that I have read this transcript 2 of my deposition and that this transcript accurately states 3 the testimony given by me, with the changes or corrections, 4 if any, as noted. 5 6 7 X 8 9 10 11 Subscribed and sworn to before me this day of 12 , 20 . 13 14 15 16 X 17 Notary Public 18 19 20 21 My commission expires: . 22 23 24 25 226 1 C O N T E N T S 2 3 WITNESS EXAMINATION 4 RICHARD J. GATES 5 By Mr. Tabackman 112 6 7 8 9 10 11 E X H I B I T S 12 EXHIBIT NUMBER IDENTIFIED 13 R. Gates Exhibit 3 135 14 R. Gates Exhibit 4 156 15 R. Gates Exhibit 5 170 16 R. Gates Exhibit 6 182 17 R. Gates Exhibit 7 203 18 R. Gates Exhibit 8 214 19 20 21 22 23 24 25