1 1 BEFORE THE UNITED STATES 2 FEDERAL ENERGY REGULATORY COMMISSION 3 4 - - - - - - - - - - - - - - - - - -x 5 In the Matter of: : 6 PJM UP-TO CONGESTION TRANSACTIONS. : 7 - - - - - - - - - - - - - - - - - -x 8 9 10 11 12 DEPOSITION OF KEVIN J. GATES 13 14 15 16 17 Washington, D.C. 18 Thursday, September 23, 2010 19 20 21 REPORTED BY: 22 SARA A. WICK, RPR, CRR 23 24 25 2 1 Deposition of KEVIN J. GATES, called for examination 2 pursuant to agreement of counsel, on Thursday, 3 September 23, 2010, in Washington, D.C., at the Federal 4 Energy Regulatory Commission, 888 First Street Northeast, 5 Room 3M-4B, at 9:06 a.m., before SARA A. WICK, RPR, CRR, a 6 Notary Public within and for the District of Columbia, when 7 were present on behalf of the respective parties: 8 9 W. BLAIR HOPKIN, ESQ. 10 ERIK C. BAPTIST, ESQ. 11 STEVEN TABACKMAN, ESQ. 12 Division of Investigations 13 Office of Enforcement 14 888 First Street Northeast 15 Washington, D.C. 20426 16 212-502-6038 17 blair.hopkin@ferc.gov 18 erik.baptist@ferc.gov 19 steven.tabackman@ferc.gov 20 On behalf of the FERC 21 22 23 -- continued -- 24 25 3 1 APPEARANCES (continued): 2 3 EARLE H. O'DONNELL, ESQ. 4 White & Case LLP 5 701 13th Street Northwest 6 Washington, D.C. 20005 7 202-626-3582 8 eodonnell@whitecase.com 9 On behalf of the Witness 10 11 Also Present: Bikash Thapliya 12 13 14 15 16 17 18 19 20 21 22 23 24 25 4 1 P R O C E E D I N G S 2 Whereupon, 3 KEVIN J. GATES 4 was called as a witness and, having first been duly sworn, 5 was examined and testified as follows: 6 EXAMINATION 7 BY MR. BAPTIST: 8 Q Mr. Gates, please state and spell your full 9 name. 10 A Kevin James Gates, K-e-v-i-n, J-a-m-e-s, 11 G-a-t-e-s. 12 Q Have you ever gone by any other names or 13 nicknames? 14 A Kevin, Kev, The Kevster. 15 Q Thank you for appearing here today. 16 My name is Erik Baptist. With me here today are 17 Blair Hopkin and Bikash Thapliya. Steve Tabackman will 18 probably be joining us as well. We are officers at the 19 Federal Energy Regulatory Commission. 20 Are you represented by counsel here today? 21 A Yes. 22 MR. BAPTIST: Please identify yourself, Counsel. 23 MR. O'DONNELL: My name is Earle O'Donnell. I'm 24 with the firm of White & Case in Washington, D.C., 701 13th 25 Street Northwest. 5 1 Mr. Baptist, as we mentioned beforehand, I 2 wanted to note on the record that we would, by agreement, 3 be preserving any objections to the questions today except 4 as to questions -- objections that relate to form or 5 privilege. 6 MR. BAPTIST: Are you representing Mr. Gates in 7 his personal capacity? 8 MR. O'DONNELL: I am. 9 MR. BAPTIST: Do you represent any other person 10 or entity in this investigation? 11 MR. O'DONNELL: Yes. 12 MR. BAPTIST: At this point, I would like to 13 mark Exhibit Number 1. 14 (Exhibit Gates 1 identified.) 15 BY MR. BAPTIST: 16 Q Mr. Gates, what I have marked as Exhibit Number 17 1 is 18 CFR Section 1b.16. I'm going to direct your 18 attention to 1b.16, subsection (b). If you could, please, 19 read it over to yourself. 20 MR. BAPTIST: Counsel, in accordance with 21 Section 1b.16, please state on the record whether you have 22 explained any potential conflict of interest to both 23 Powhatan and Mr. Gates. 24 MR. O'DONNELL: I have done so. 25 BY MR. BAPTIST: 6 1 Q Mr. Gates, would you like to take a break to 2 consider your representation or to confer with your 3 counsel? 4 A No, thank you. 5 Q You can put that exhibit away now. 6 I'm taking your testimony today in a proceeding 7 being conducted pursuant to the Federal Energy Regulatory 8 Commission's regulations. I do not have authority to grant 9 you immunity, nor do I intend to grant you immunity. 10 Do you understand? 11 A Yes. 12 Q For the purposes of this deposition, I am an 13 officer of the United States, and so is Mr. Hopkin and 14 Mr. Thapliya and Mr. Tabackman. 15 Do you understand that we are here in our 16 official capacity for the United States government? 17 A Yes. 18 Q Whoever knowingly or willfully states or 19 subscribes under oath to any material matter that he or she 20 does not believe to be true to an officer of the United 21 States is guilty of perjury and may be fined or imprisoned 22 or both. 23 Do you understand? 24 A Yes. 25 Q Have you ever been deposed before? 7 1 A No. 2 Q We're going to go over some general instructions 3 that will apply throughout the deposition. If you do not 4 understand a question, let me know, and I will try to make 5 it more clear, but if you give an answer, we're going to 6 assume and the record will reflect that we understood -- 7 that you understood the question. 8 Okay? 9 A Yes. 10 Q I'm conducting this deposition and will be the 11 primary person asking you questions. Mr. Hopkin and 12 Mr. Thapliya may also ask you questions at some point 13 during this deposition. You are directed to answer each 14 question fully and truthfully. If your counsel objects to 15 a question, the objection will be noted for the record, but 16 you will still be expected to answer the question. 17 Okay? 18 A Yes. 19 Q You may refuse to answer any question or to give 20 evidence that may incriminate you or may subject you to a 21 fine, penalty, or forfeiture. This is a right you have 22 under the Fifth Amendment of the United States 23 Constitution. If you refuse to answer a question, you must 24 explain why you refuse to answer it. If you assert a 25 privilege not to answer, such as the grounds of 8 1 self-incrimination, you must assert the privilege 2 personally. 3 Do you understand your rights? 4 A Yes. 5 Q After you are finished answering your question 6 or before I ask my next question and if you need a break, 7 just let us know, and we will take a break after you've 8 completed your answer. 9 Okay? 10 A Okay. 11 Q You must answer audibly, as gestures and nods 12 will not be recorded by the court reporter. 13 Do you understand? 14 A Yes. 15 Q And please do not try to speak when I'm asking a 16 question and just wait for me to finish asking the question 17 before you give your answer, and I will accord you the same 18 deference as well, because the court reporter can't write 19 when there's a back and forth between counsel and the 20 witness. 21 Do you understand? 22 A Yes. 23 Q Are you taking any medication or suffering from 24 any physical or mental illness or condition that could 25 prevent you from testifying today? 9 1 A No. 2 Q Are you aware of any reason today why you cannot 3 give full and complete answers to my questions today? 4 A I don't know what your questions are, so I may 5 not be able to give complete answers to your questions. 6 Some of them may require additional research. 7 Q Okay. 8 BY MR. HOPKIN: 9 Q But just to review, you're not suffering from 10 any physical ailment, you're not feeling under the weather, 11 nothing like that? You feel cogent, coherent, and ready to 12 participant in the deposition? 13 A Yes. 14 BY MR. BAPTIST: 15 Q Are you appearing here today voluntarily? 16 A Yes. 17 Q I will be handing you a few exhibits throughout 18 the deposition today, and please do not mark on them if you 19 do not want us to see your notes, because we will collect 20 the exhibits at the end of the deposition today. 21 Do you understand? 22 A Yes. 23 BY MR. HOPKIN: 24 Q Would you like some scrap paper or a pen or 25 anything like that? 10 1 A Sure. I actually have my own folder, if I could 2 get that. 3 Q Please. 4 A Actually, a question. You said earlier that all 5 responses must be audible. Can responses also be drawn? 6 BY MR. BAPTIST: 7 Q If you give a written or drawn response, that 8 will probably end up being an exhibit for this deposition, 9 but it is okay to do so if you're trying to explain a 10 certain answer to a question. 11 A Okay. 12 Q I'm going to now ask you a series of questions 13 about how you prepared for today's deposition. Aside from 14 your attorneys, with whom did you talk to in preparation 15 for this deposition? 16 A I spoke with Larry Eiben and Rich Gates. 17 Q When did you speak with Mr. Eiben? 18 A I speak to Mr. Eiben daily. Most of the 19 conversations are not related to this deposition. 20 Q When did you speak to Mr. Eiben about this 21 deposition? 22 A Most recently, yesterday, just to coordinate 23 logistics and to figure out what his schedule was and to 24 see if there was opportunities to get together after the 25 deposition. 11 1 Q During this conversation, did you discuss 2 anything other than logistics? 3 A I think we also discussed the fees that we're 4 paying to White & Case. 5 Q Did you speak to Mr. Eiben before that last 6 conversation about this deposition? 7 A I spoke to him earlier as related to our 8 meetings and other discussions with White & Case, but these 9 discussions were not significant. They were, I guess, 10 largely discouraged by White & Case, and most discussions 11 were very superficial. 12 Q And when you say "superficial," can you explain? 13 A Very high level. I guess I should say, most of 14 the discussions were very high level about the expectation. 15 We've never done anything like that or never been in this 16 situation before. So kind of just trying to assess each 17 other's sense as to the situation and how the deposition 18 may play out. Larry had been previously deposed on an 19 unrelated matter. So he was -- shared with me general 20 thoughts of his previous deposition. 21 Q When you say "we have never done anything like 22 this," what do you mean by "this"? 23 A Been called in by any office of enforcement to 24 be deposed. 25 Q Okay. When did you speak with Rich Gates about 12 1 this deposition? 2 A Yesterday. 3 Q What did you discuss with him? 4 A I specifically asked him information. I was on 5 the train ride down last night, and I thought of a question 6 that you guys may ask, and I asked him to research it for 7 me. 8 Q And what was that question? 9 A When was -- Alan Chen from the HEEP Fund, when 10 did he come to West Chester recently. I forgot the 11 specific date. But for the record, it was June 25th. 12 Q That's what Mr. -- that's what Rich Gates told 13 you? 14 A Yes. 15 Q Did you say June 27? 16 A I believe I said 25th. 17 Q Why did Mr. Chen come to West Chester on June 18 25th? 19 A To discuss his trading. 20 Q His trading with regard to the up-to congestion 21 transactions at PJM during June, July, and August of 2010? 22 A At the time the discussion was specific to his 23 trading in June, but the plans for trading going forward. 24 Q And what did Mr. Chen tell you? 25 A He discussed many things -- I believe we 13 1 discussed many things relating to the trading, including 2 collateral requirements, risks of the trade, other 3 opportunities in other power markets. 4 BY MR. HOPKIN: 5 Q When you say "the trading," what trading are you 6 referring to, sir? 7 A The up-to congestion trading, if he was 8 executing on behalf of Powhatan. 9 Q Also, I believe in your prior answer, you 10 referred to "the trade." What did you mean by that? 11 A I'm sorry. I don't recall the prior answer. 12 MR. BAPTIST: Could you read back his prior 13 answer, please. 14 (The reporter read the record as requested.) 15 BY MR. HOPKIN: 16 Q So in that answer, you referred to "trading," 17 and you also said "the trade," and I'm wondering how you 18 used those terms, if you could flush that out for me? 19 A Risks of the trade were specific to risks of the 20 up-to congestion trade. 21 MR. HOPKIN: Thank you. 22 BY MR. BAPTIST: 23 Q What were those risks of the up-to congestion 24 transactions? 25 A I believe that there were numerous risks that he 14 1 described. As I recall, the risks were -- some of the 2 risks included differences between the nodal pricing, 3 day-ahead versus real-time of the nodal pricing, so there 4 was sometimes -- well, there was a exposure to these two 5 pricing or settling mechanisms. Another was a risk of 6 trades not being accepted into the market. I believe the 7 trades are submitted and there's an auction that either 8 accepts or rejects trades, so the uncertainty associated 9 with that auction. 10 BY MR. HOPKIN: 11 Q Is there a name for that risk that you're aware 12 of? 13 A I don't recall. And another significant risk 14 was the fact that there was a fixed guaranteed payment to 15 establish a trade with an unknown payout. 16 Q What was the fixed guaranteed payment, if you 17 know? 18 A There were several components of it. One was 19 the cost associated with reserving the transmission, which 20 I believe was generally 65 cents when it was -- from the 21 MISO interface to PJM, and then there were other 22 transaction charges. 23 To be candid, I don't recall -- I can't speak 24 specifically to what they are, but they averaged 25 to 37 25 cents. Actually, I believe during our involvement, they 15 1 averaged 36 cents per megawatt. 2 Q You said Mr. Chen discussed the risks of the 3 trades. Did you discuss the benefits? 4 A Yes. 5 Q What were those benefits? 6 A From our perspective, the benefit was an 7 investment that wasn't correlated with -- an investment 8 that we expected to make money that wasn't correlated with 9 other personal investments that we had. We could make 10 money in the up-to congestion and lose money in the stock 11 market in one day. 12 BY MR. HOPKIN: 13 Q Are you referring to trading that Powhatan was 14 engaging in as a business or your own personal trading such 15 as trading you might engage in in an IRA account or 16 otherwise for your own account? 17 A I'm referring to -- the benefits that Alan 18 described were benefits that we perceived -- we perceived 19 them to be benefits because his trading wasn't correlated 20 and wasn't related to our other trading. 21 Q And when you say "our other trading" -- 22 A Not Powhatan, other -- this is the only 23 involvement that Powhatan had in the power markets, but 24 other trading or other personal investments that we have. 25 BY MR. BAPTIST: 16 1 Q Who is the "we"? 2 BY MR. HOPKIN: 3 Q Just as a further clarification, you anticipated 4 my question and jumped in. You answered the question I was 5 going to ask, but just for the court reporter's sanity and 6 just the dynamics of this, it's going to take a little bit 7 for you to get used to, but you have to wait for me to 8 finish the question before you can start answering. 9 Otherwise, she won't be able to properly record us if we're 10 both speaking at the same time. 11 A Sorry. 12 Q That's okay. I'm sure it will happen again, and 13 we will take care of it. It's not a big deal. 14 Go ahead. 15 MR. BAPTIST: Can you read back my question. 16 (The reporter read the record as requested.) 17 THE WITNESS: The "we" are the investors in 18 Powhatan. 19 BY MR. BAPTIST: 20 Q Who are the investors in Powhatan? 21 A Myself, Rich Gates, Larry Eiben, Chao Chen, 22 C-h-a-o, Chen. 23 Q Any relations to Alan Chen? 24 A I do not believe so. Sam Harris, Mike 25 Frederick, Greg Sekelsky. 17 1 BY MR. BAPTIST: 2 Q How do you spell that last name? 3 A S-e-k-e-l-s-k-y. 4 Q Are those all of the investors in Powhatan? 5 A I believe so. Are there eight, myself included? 6 Q Yes. No, I have seven actually. 7 A Eric Newman. 8 Q How do you spell Newman? 9 A N-e-w-m-a-n. 10 Q Going back to your conversation with Mr. Chen on 11 June 25th, do you recall if he discussed any other benefits 12 of the up-to congestion transactions? 13 A Yes. 14 Q What were they? 15 A That he could have an opportunity to make money 16 based upon spreads in nodal pricing and be compensated for 17 his risk for taking -- the risk that he was assuming by 18 paying a fixed amount in transaction charges by collecting 19 a transmission lost credit. 20 BY MR. HOPKIN: 21 Q Is that sometimes referred to as the marginal 22 surplus allocation? 23 A I believe so. 24 MR. HOPKIN: Thank you. 25 BY MR. BAPTIST: 18 1 Q Did he discuss any other benefits? 2 A He did discuss that it was -- I believe the 3 liquidity was attractive, the fact that it was fully 4 transparent and open to the marketplace. 5 Those are all that I can recall at this point. 6 Q When you say "the liquidity was attractive," was 7 there a lot of liquidity or a little? 8 A It was a very liquid investment. 9 BY MR. HOPKIN: 10 Q So the investment itself was liquid? That 11 wasn't a reference to the liquidity of the market in which 12 Mr. Chen was trading? 13 A Yes. 14 MR. HOPKIN: Okay. 15 BY MR. BAPTIST: 16 Q Do you recall any other benefits that Mr. Chen 17 discussed at that June 25th meeting? 18 A At this point I cannot recall any additional. 19 BY MR. HOPKIN: 20 Q You indicated that Mr. Chen traveled to West 21 Chester to discuss this with you. 22 Do you remember saying that? 23 A Yes. 24 Q Why not just pick up the phone and talk to each 25 other that way? Why did Mr. Chen come physically to visit 19 1 with you? 2 A We thought it would be a more productive 3 conversation in person. 4 Q Was this a particularly important meeting? 5 A I don't understand the question. 6 Q Sure. Let me ask another question. How many 7 times has Mr. Chen traveled to West Chester to speak about 8 trading with you or anyone else at Powhatan? 9 A I believe three. 10 Q Aside from the trip in June, when else did 11 Mr. Chen visit either yourself or anyone else affiliated 12 with Powhatan? 13 A I don't recall -- October of '08 maybe and maybe 14 some time in '09. 15 Q So am I correct that this was not a regularly 16 scheduled meeting with Mr. Chen? This is something you did 17 fairly infrequently? 18 A Yes. 19 Q Was there any particular reason that Mr. Chen 20 came on June 25th? Was there something particularly 21 important that you needed to discuss with him that couldn't 22 be handled over the phone? 23 A I'm not sure how to answer that question. I 24 guess technically a lot of it could have been answered on 25 the phone. But it was a way to generally get more 20 1 comfortable with each other. 2 Q To follow up on that, how would you describe 3 your relationship with Mr. Chen? 4 A It was a pretty standard business relationship. 5 It wasn't really open, as open as I would have liked, but I 6 was -- at the time I was generally satisfied with the 7 relationship. 8 MR. HOPKIN: Okay. 9 BY MR. BAPTIST: 10 Q You're speaking in the past tense. Has your 11 relationship with Mr. Chen terminated since -- I will stop 12 there. Has it since terminated? 13 A How do you define "relationship" with him? 14 Q You said you had a standard business 15 relationship with him. Do you continue to have a business 16 relationship with Mr. Chen? 17 A Mr. -- actually, I think it's Dr. Chen maybe. 18 Dr. Chen is not trading or entering trades on behalf of 19 Powhatan at this point. I believe the relationship has not 20 terminated, though. There hasn't been a settlement of fees 21 or further discussions. 22 BY MR. HOPKIN: 23 Q Is it fair to say, however, that the nature of 24 your relationship with Dr. Chen has materially changed? 25 A Yes. 21 1 Q Okay. When did this happen? 2 A I guess the first notice, I believe, was on 3 August 2nd, and he indicated that he had received a call 4 from Dr. Bowering. That was when it first had changed 5 slightly, and I think it changed more significantly when we 6 received a letter from your office. 7 Q And was that letter -- are you referring to the 8 data request you received from the Office of Enforcement? 9 A Yes. 10 MR. O'DONNELL: Can we just go off the record 11 for a second? 12 MR. HOPKIN: Yes, please go off the record. 13 (A discussion was held off the record.) 14 MR. BAPTIST: We can go back on the record. 15 BY MR. BAPTIST: 16 Q You said the relationship with Dr. Chen was not 17 as open as you would have liked. 18 Can you, please, expand on that statement? 19 A We wanted to know very specifically what he was 20 doing and how he was doing it. He was unwilling to provide 21 the transparency and disclosure that we had hoped for. 22 MR. BAPTIST: Can you, please, read his question 23 back, please. 24 (The reporter read the record as requested.) 25 BY MR. BAPTIST: 22 1 Q What, if any, type of transparency did Dr. Chen 2 provide you? 3 A He described the daily positions that we had in 4 a summary detail, the daily P&L. He described on a high 5 level the mechanics of the trade and the risks of the 6 trade. 7 Q You described that he provided you the daily 8 P&L, the trades, the positions, the mechanics of the trade, 9 and the risks of the trade. 10 Anything else? 11 A Guidance on collateral issues. I believe he 12 also kept us somewhat informed of the shareholder meetings 13 and the discussions at PJM as it relates to the up-to 14 congestion trade. He discussed with us other trading 15 vehicles as well, FTRs and other ISOs. 16 BY MR. HOPKIN: 17 Q He didn't actually trade FTRs on behalf of 18 Powhatan, did he? 19 A No. 20 Q It was just up-to congestion transactions? 21 A I believe so. 22 Q You believe so? Are you certain about that, or 23 are you not sure? 24 A The agreement that we had with him dictated just 25 up-to congestion. We never went back and reconciled his 23 1 trades. I have no reason to believe that he traded 2 anything besides up-to congestion, but I didn't 3 independently verify that. 4 Q Would it have been possible for him to do so on 5 behalf of Powhatan without having your consent or knowledge 6 of that? 7 A I don't know. 8 MR. HOPKIN: Okay. Thank you. 9 BY MR. BAPTIST: 10 Q You said he gave you guidance on collateral 11 issues. What are those collateral issues? 12 A Posting the money to the Blackrock collateral 13 account that PJM required, and it's my understanding it's a 14 complex -- I know it to be a complex logic that is used to 15 dictate what the collateral requirements are. So he helped 16 us interpret those requirements. 17 Q Did Dr. Chen trade on behalf of Powhatan in 18 other ISOs? 19 A No. 20 Q Going back to your June 25th meeting with 21 Dr. Chen, can you just go back and describe how this 22 meeting took place or how it was initiated? 23 A It was initiated based upon our request to -- 24 based upon our request. We wanted to learn more about his 25 trading and the risks associated with it, and we wanted to 24 1 learn more about the power markets in general. He flew up 2 the day before. I went out to dinner with him. We were 3 supposed to meet in the office the next day, but there was 4 an awful storm that evening that wiped out electricity. So 5 the meeting was, I guess, changed at the last moment. I 6 had spent the morning with him at my house, and then when 7 electricity finally came up, we went back into the office. 8 And it wasn't as productive as I had hoped, because there 9 were a lot of other distractions. 10 Q How long was your meeting with Mr. Chen? 11 A Four, five hours. Actually, can I clarify, when 12 you say "your," I'm assuming it's plural, collective, how 13 long did we meet with him? I individually did not meet 14 with him that long. 15 Q Correct. 16 BY MR. HOPKIN: 17 Q If at any point you have any kind of uncertainty 18 about any of the words we use in the question or if you 19 want to elaborate on an answer at all, please just speak 20 up, and we will try and take care of it. 21 A Unfortunately, I thought of my question after I 22 answered it. 23 Q That's fine. At the end of the day today, we 24 will provide you and your counsel an opportunity to reflect 25 as to whether you would like to add anything. So you will 25 1 have that opportunity, too. 2 BY MR. BAPTIST: 3 Q We started this conversation based on your phone 4 call to Rich Gates on the train. So let's go back to that. 5 Did you talk to Rich Gates about anything else in that 6 conversation? 7 A I don't believe so. 8 Q Did you speak with Rich Gates about this 9 deposition at any point before that call on the train? 10 A Yes. 11 Q What did you discuss? 12 A He had previously been deposed by the SEC, and 13 he explained to me his experience with the SEC. 14 Q Do you know what the subject of that deposition 15 or SEC litigation was about? 16 A There was -- I believe, and I'm not certain, 17 there was a broker who was involved in market timing 18 activities and annuities. Rich had done business with this 19 broker, and so he was a witness or whatnot that the SEC was 20 trying to get additional information for for purposes of, I 21 guess, this case against this other broker. 22 Q Was there any other time that you spoke to Rich 23 Gates about this deposition? 24 A I don't believe so. 25 Q Outside of Rich Gates and Larry Eiben, did you 26 1 discuss this deposition with anybody else? 2 A My wife. 3 Q What did you discuss with your wife? 4 A Just the experience in general. She was asking 5 questions, and I was trying to answer them. She works as a 6 physician's assistant. So this is very new territory for 7 her. 8 Q Did you take steps today to educate yourself 9 about the areas to be covered in today's deposition? 10 A Yes. 11 Q Did you review any documents? 12 A Yes. 13 Q Can you identify those documents? 14 A I reviewed the statements that Alan Chen sent. 15 I reviewed the filing that Blair Hopkins in the marketing 16 analytics or monitoring group -- not Blair. I'm sorry. 17 Q Bowering? 18 A Bowering. Sorry. 19 MR. HOPKIN: We look very much alike. 20 THE WITNESS: Prior to today's meeting, you guys 21 were just names. 22 Dr. Bowering had filed in early August. I had 23 reviewed the filing that PJM made with FERC on August 18th, 24 I believe. I had reviewed the filing that FERC made on 25 this past Friday, I believe the 17th of September. I had 27 1 reviewed e-mails. I had reviewed the advisory agreement 2 that defines the relationship between Powhatan and HEEP 3 Fund. And I'm sure there are others that I can't think of. 4 BY MR. BAPTIST: 5 Q You said you reviewed statements that Dr. Chen 6 sent you. What are those statements? 7 A Reports that detailed the exposure that HEEP 8 Fund had and that Powhatan had, and the daily P&L and the 9 daily costs that we were paying. 10 Q How many reports did you review? 11 A 10 to 15. 12 Q Are these regularly issued reports from 13 Dr. Chen? 14 A They were. 15 Q How often did you receive them? 16 A Generally, daily. 17 Q You also said you reviewed e-mails. Can you 18 describe the nature of these e-mails? 19 A E-mails with -- other e-mails that I had had 20 with Alan, e-mails that I had had with PJM, and e-mails 21 that I had had with the investors of Powhatan. 22 Can I go back and add a couple other documents 23 that I reviewed? 24 Q Yes, please. 25 A I reviewed the application paperwork that was 28 1 submitted to PJM to establish membership, Powhatan's 2 membership. 3 Q Is that it? 4 A For now; for now. 5 Q Going back to the e-mails that you just 6 discussed, do they all relate to the up-to congestion 7 transactions that were conducted on behalf of Powhatan? 8 A No. 9 Q What else -- please discuss the nature of these 10 e-mails. 11 A Some of the e-mails were related to exploring 12 other opportunities with Alan outside of up-to congestion 13 at other ISOs. Some of the e-mails were internally talking 14 about other possible traders that we could work with or had 15 worked with. Some of the e-mails included logistics, when 16 did Alan come to West Chester. 17 Q Did you review any trade press articles about 18 up-to congestion transactions or this investigation? 19 A I don't know what a trade press article is. 20 BY MR. HOPKIN: 21 Q An article from Megawatt Daily, for example, or 22 Platts Inside FERC. 23 A No. I did read some article from a law firm, an 24 online law firm talking about this investigation. 25 Q Which law firm was that? Do you recall? 29 1 A I don't recall. I just Googled "up-to 2 congestion PJM," and something came up. I don't believe it 3 was White & Case. I know it wasn't White & Case. 4 Sometimes law firms try to market themselves by giving 5 people updates on the marketplace. 6 MR. HOPKIN: Okay. 7 BY MR. BAPTIST: 8 Q Have you had conversations or communications 9 with anybody other than your attorneys about this 10 investigation or any related investigation? 11 A Can you repeat that question? 12 Q Why don't we strike that question and move on. 13 BY MR. HOPKIN: 14 Q Before we leave that, you indicated you had a 15 number of discussions with Mr. Eiben about this 16 investigation; is that correct? 17 A Yes. 18 Q Okay. I wanted to revisit that briefly. When 19 did you first start talking to Mr. Eiben about this 20 investigation? 21 A The date that we received the letter from the 22 FERC Office of Enforcement. 23 Q Okay. 24 A And I believe it's noteworthy that I think we 25 received that the day after it was sent electronically. 30 1 Q During this conversation, what did you say to 2 each other? 3 A We were trying to figure out how to proceed and 4 how to respond to the questions that were asked. It 5 involved figuring out questions like do we need attorneys; 6 if so, whom. Do we need to share an attorney with Alan; if 7 so, how do we make those decisions. It involved wild 8 speculation in terms of how this could play out. 9 Q After that conversation -- is there anything 10 else you would like to add to your answer? 11 A I believe that that was the specifics of our 12 initial discussion that we had had after receiving that 13 letter. 14 Q After that initial discussion, did you have a 15 subsequent discussion with Mr. Eiben about the 16 investigation? 17 A Yes. 18 Q Okay. When was that? Do you recall? 19 A Likely the next day. 20 Q Okay. Do you recall the substance of that 21 conversation? 22 A It was much of the same, what attorneys to speak 23 with and trying to figure out how to proceed. 24 Q Okay. And again, after that second discussion, 25 did you discuss it with him again? 31 1 A I suspect that there were numerous conversations 2 along those lines. 3 Q Other than the issues you just described, you 4 know, in terms of how were you going to handle it and what 5 this meant and so forth, did you ever discuss the substance 6 of what you believed the investigation would be about? 7 A Probably. Early on we had had discussions of 8 trying to figure out what the problem was with our 9 involvement. I think we were quite perplexed based upon 10 our knowledge of the marketplace as to what we were being 11 accused of. I don't recall specifically, but I would have 12 to guess that there were discussions of what possibly could 13 have gone wrong or what's the problem here. 14 Q At any point, did you or Mr. Eiben or anyone 15 else at Powhatan go back and review trading records, 16 Dr. Chen's trading records? 17 A Can you repeat that question? 18 MR. HOPKIN: Sure. Can you, please, read the 19 question back for the witness. 20 (The reporter read the record as requested.) 21 THE WITNESS: I certainly did. I reviewed his 22 records that he had sent. I don't know if Larry did or the 23 extent of the research that he did. 24 BY MR. HOPKIN: 25 Q Okay. And what was in these reports? 32 1 A Daily reports that Alan would send describing 2 megawatts that HEEP had, Powhatan had, the estimation of 3 the transmission loss credit, the other fixed costs 4 associated with the trades. The report also had some more 5 granular -- excuse me, more high-level, but not totally 6 granular, detail summary of the exposure by hour and the 7 settlements by hour for the previous day, the current day, 8 and the next day. 9 Q Am I correct, then, that in addition to having 10 access to trading records for Powhatan that Dr. Chen was 11 performing on behalf of Powhatan, did you also have access 12 to Dr. Chen's records as they relate to HEEP? 13 A Only to the extent that he was willing to 14 provide that. 15 Q Okay. Earlier in your testimony this morning, 16 you mentioned that there were some -- you had some 17 dissatisfaction with the level of transparency and 18 disclosure that Mr. Chen provided with respect to his 19 trading records. 20 Do you recall that? 21 A I don't recall specifically saying related to 22 his trading records, but his trading in general. I believe 23 we were generally dissatisfied. We were hoping to learn 24 more about the marketplace in general. 25 Q Can you tell me specifically what sorts of 33 1 information you would have liked to have seen that you were 2 not able to see? 3 A To clarify, I think we could have seen 4 everything related to his trades. We were -- as a 5 representative of LSE Capital Management, we were the 6 managing member of Powhatan and were members of PJM. I 7 believe -- and I don't know, but I believe there was a lot 8 of information related to the trading that we could have 9 observed online. We didn't have the time or the know-how 10 to extract that information off of the system. So we were 11 dependent upon Alan, and that's why we had hired Alan in an 12 advisory relationship, to summarize and help us process and 13 interpret the information. 14 Q Did you ever express your dissatisfaction with 15 Dr. Chen about the level of transparency he was willing or 16 able to provide? 17 A Definitely indirectly, but sometimes directly, 18 yeah. We asked him to move to West Chester, and he said he 19 wouldn't, and we said we want a closer relationship, come 20 to West Chester, let's change it. And he said no, no, no. 21 And we told him that we were disappointed that he wasn't 22 willing to move to West Chester. 23 Q Aside from that, I'm thinking specifically, you 24 know, did you ever have an e-mail conversation or phone 25 conversation with Dr. Chen where you would ask for 34 1 information and he declined to provide it? 2 A I suspect so, yes. I don't recall specifically. 3 Q Let me try coming at it from a slightly 4 different angle. Whenever you asked Dr. Chen for 5 additional transparency or clarity as to what he was doing, 6 what was his response as to why he couldn't or wouldn't 7 provide it? 8 A When we say transparency and disclosure, we 9 wanted a closer relationship. We wanted him to help 10 provide support in the markets, analytical and modeling 11 support, and his general response was I don't need your 12 help, I'm okay. 13 Q Okay. But with specific focus on the up-to 14 congestion transactions at PJM, the trading he was 15 performing on behalf of Powhatan, I believe you testified 16 earlier that with respect to that trading you were not able 17 to have the level of detail you would have liked to in 18 terms of being able to see what Mr. Chen was doing; is that 19 right? 20 A I believe we had the level of detail through the 21 PJM -- we may have had the level of detail through PJM's 22 site. We were hoping that he would process that 23 information for us and share it with us. So -- 24 Q At some -- sorry. Go ahead. 25 A So we didn't get the assistance there that we 35 1 would have hoped and didn't know the specifics of the 2 actual trades that were being put on and how the strategy 3 had changed. We knew that it did change, some of his 4 strategies did change, but we didn't fully understand the 5 specifics of them. 6 Q Did he give you a reason as to why he wouldn't 7 help you out in this regard? 8 A I don't believe that he did give us a reason. 9 Q He would just say no? 10 A No, he wouldn't just say no. He would -- I 11 think his general approach was to change the subject. 12 Q Fair enough. 13 At any point in your relationship with Dr. Chen 14 did you have an opportunity to look or observe HEEP's 15 trading activity? 16 A He provided in these daily reports information 17 on both HEEP and Powhatan trades. 18 Q Do you have an understanding as to why that is? 19 A Could you help me understand -- 20 Q Let me ask that over again. Do you know why 21 Mr. Chen provided you not just Powhatan's trading but also 22 HEEP's? 23 A Yes. 24 Q And why is that, or why was that? 25 A The agreement that we had with him was that 36 1 Powhatan was supposed to be traded similarly to HEEP. 2 Q Okay. And did you, in fact, observe that that 3 was the case? 4 A Generally, they were traded very similarly. 5 MR. HOPKIN: Okay. We will come back to that 6 later. 7 BY MR. BAPTIST: 8 Q Let me make sure I understand. You said you 9 wanted to see more information related to the trades that 10 Dr. Chen was conducting; correct? 11 A We wanted more information about everything, the 12 trades, the marketplace in general, other opportunities in 13 the market -- in the power markets. 14 Q And was it more that you wanted information that 15 he can translate for you? Let me start over. 16 You said you wanted him to process the 17 information for you. Is that what you meant by you wanted 18 everything related to the trades? 19 A That response was specific to the trading 20 activity. But in general, we wanted more information -- I 21 believe Alan to be a wealth of knowledge in these markets, 22 and we wanted to just generally learn about these markets. 23 Q Are you aware of any individuals or companies 24 who have received data requests or subpoenas in this 25 investigation or any related investigation? 37 1 A Yes. 2 Q Who are they? 3 A Powhatan, HEEP Fund, and CU Fund. 4 Q How did you find out about HEEP and CU Fund? 5 A Alan told us about HEEP. He informed us that he 6 received a letter. Then CU Fund, during the middle of 7 August when we were evaluating attorneys, I spoke with an 8 attorney who ruled herself off due to conflicts, and she 9 casually mentioned that she was aware of three entities, 10 and she named these three funds. 11 Q Who was this attorney? 12 MR. O'DONNELL: Subject to check, was it Carol 13 Smoots? 14 THE WITNESS: I believe it was Carol Smoots. 15 MR. BAPTIST: Can you read Mr. Gates's last 16 response, please. 17 (The reporter read the record as requested.) 18 BY MR. BAPTIST: 19 Q Just for the record, I don't want you to state 20 any privileged conversation you've had with an attorney or 21 whether you were seeking advice from an attorney. So I 22 want to put that out there. 23 MR. BAPTIST: Any time you wanted to stop my 24 line of questioning if you think it intrudes on the 25 attorney-client relationship, please let me know. 38 1 MR. O'DONNELL: If I can only add, I think the 2 conversations between a person who is looking for counsel, 3 even if they don't retain that, would be privileged. So -- 4 but it goes to the nature of the legal advice. So I don't 5 have any standing objection. I just want to walk the line 6 carefully, and I think you're appropriately handling it. 7 MR. BAPTIST: And please let me know if I come 8 close to that line. 9 BY MR. BAPTIST: 10 Q Who were those three entities that Ms. Smoots 11 identified, if you can answer without revealing privileged 12 information? 13 A I'm sorry. I'm not sure I understand the 14 question. Was the question which three entities did Ms. 15 Smoots identify? 16 Q Yes. 17 A These three funds: Powhatan, HEEP, and CU Fund. 18 Q You mentioned that Dr. Chen told you about the 19 HEEP Fund being investigated; correct? 20 A Yes. 21 Q When did you have this conversation with 22 Mr. Chen? 23 A The day or the day after he received the letter. 24 Q When did Dr. Chen receive this letter? 25 A Around the 17th of August, 18th. I don't recall 39 1 the specifics, but I believe he received it immediately 2 after it had been sent. 3 Q Can you, please, tell me what you and Dr. Chen 4 discussed in this conversation. 5 A He asked if we also received a letter, if 6 Powhatan received a letter. 7 Q Did he ask anything else? 8 A In that initial discussion, that was it, I 9 believe. 10 Q What was your response to Dr. Chen? 11 A I don't know; let me check. 12 BY MR. HOPKIN: 13 Q When you said "let me check," would that be 14 because this was over e-mail? How would you go about that? 15 A Checking e-mail. 16 MR. HOPKIN: Thank you. 17 BY MR. BAPTIST: 18 Q Did you discuss anything else with Dr. Chen 19 during this conversation? 20 A In that conversation? 21 Q Yes. 22 A No. 23 Q Have you had subsequent conversations with 24 Dr. Chen? 25 A Yes. 40 1 Q When was your next conversation with Dr. Chen 2 after he received that letter in August? 3 A Either later that afternoon or the next day. 4 Q What was discussed during that conversation? 5 A We confirmed that Powhatan also received a 6 letter. 7 Q Did you receive anything else? 8 A If not that in that conversation, in a 9 subsequent conversation, we discussed how to -- the 10 logistics of responding to the letters, how it goes in. We 11 discussed also these preliminary discussions of how to 12 proceed, what attorneys he -- he had spoken with an 13 attorney who had ruled himself out due to a conflict. He 14 was looking for recommendations of other attorneys. 15 Q Did you ever discuss the substance of the 16 investigation with Dr. Chen? 17 A Yes. 18 Q When did you have this discussion? 19 A During the period when -- in the next week or so 20 prior to signing up White & Case, the period from we had -- 21 after receiving the letter to the period where we had 22 counsel that advised against having overly detailed 23 conversations. 24 Q Do you know the time period, specific dates? 25 A No. 41 1 Q What did Dr. Chen and you discuss about the 2 substance of the investigation? 3 A We discussed the filing that PJM had made to 4 FERC. We discussed -- again discussed the risks associated 5 with the trade. We discussed days when moneys were lost 6 from the trading. 7 Q Are you aware of any other individuals or 8 companies who are under investigation with regards to this 9 investigation? 10 A No. 11 MR. BAPTIST: I think this is a good time to 12 take a break. Let's go off the record. 13 (Recess.) 14 MR. BAPTIST: Let's go back on the record. 15 BY MR. BAPTIST: 16 Q Mr. Gates, are you currently employed? 17 A Yes. 18 Q Who is your employer? 19 A TFS Capital. 20 Q What is TFS Capital? 21 A A registered investment advisor. 22 Q Where is it located? 23 A There's two offices. I work in the West 24 Chester, Pennsylvania, office. We also have an office in 25 Richmond, Virginia. 42 1 Q Do you have a title? 2 A Founder, owner, portfolio manager. 3 Q Are there any other co-founders or co-owners? 4 A Yes. 5 Q Can you, please, identify them? 6 A The other co-founders, the business was started 7 with Larry Eiben and my identical twin brother, Rich Gates. 8 We've since made other people partners of the firm. Not 9 officially, but have structured the compensation so they're 10 more aligned to an ownership interest of the firm. 11 Q So the partners have an ownership interest in 12 TFS Capital? 13 A Larry, Rich, and I are the three owners of TFS 14 Capital. But we've structured some of the employee 15 relation -- arrangements that we have with employees, such 16 that they're not employed at will, such that if the 17 business is sold they would participate in it. Basically, 18 it's an arrangement where they're more like owners than 19 employees at will. 20 BY MR. HOPKIN: 21 Q Is it correct that TFS Capital is an LLC? 22 A Yes. 23 Q Who is the managing member of the LLC? 24 A I believe the three of us are. Larry could 25 speak to that better than I. 43 1 Q And "the three of us" being Larry, yourself, and 2 your twin brother, Rich? 3 A Yes. 4 BY MR. BAPTIST: 5 Q When was TFS Capital formed? 6 A I believe in '97. 7 Q And that's when you founded TFS Capital; 8 correct? 9 A Uh-huh. 10 Q Are you employed anywhere else currently? 11 A What does "employed" mean? 12 Q Are you affiliated with any other entity? 13 A Yes. 14 Q Can you tell me which entities? 15 A Numerous other entities. The funds that TFS 16 Capital manages, we have two registered mutual funds and 17 two hedge funds, TFS Market Neutral -- it may be easier, if 18 you want -- I see a diagram starting. It's going to get a 19 little bit complicated. If it might be easier if I drew 20 diagrams, if you wanted. 21 MR. HOPKIN: Sure. 22 THE WITNESS: If it would make it easier, I'd be 23 happy to help. 24 BY MR. BAPTIST: 25 Q If you could do a diagram and also give a 44 1 narrative of how the diagram works, that would be helpful. 2 A Okay. TFS Capital. 3 BY MR. HOPKIN: 4 Q Why don't we do this. Why don't you draw the 5 diagram with as much detail as you can, and then maybe we 6 will take a five-minute break. I will run upstairs and 7 photocopy it. That way it can all be in front of us, and 8 we can have a discussion based upon the same piece of 9 paper. 10 A Fine. And when you say "other entities," am I 11 affiliated with -- I am a stockholder of Berkshire 12 Hathaway. Those affiliations, I assume, we're not 13 interested in. 14 MR. HOPKIN: Go ahead. 15 BY MR. BAPTIST: 16 Q When I say "affiliations," either employment or 17 you're an officer or board member, those types of 18 affiliations. 19 BY MR. HOPKIN: 20 Q Ownership control, officer, board member, 21 employee. If you're simply an investor and you own stock 22 in a company like Berkshire Hathaway, we're not interested 23 in those. 24 A Own at least 5 percent of the shares outstanding 25 or something like that? 45 1 Q Sure, we can use that as the threshold. How 2 many companies are we talking about roughly? Because I 3 don't want this to get too far off track. 4 A I think I can do it -- and the question is 5 companies that I'm currently affiliated with; is that 6 right? 7 Q Correct. Well, let me modify that answer. The 8 time period we're most -- we're primarily concerned with 9 would be roughly May 2010 through August 2010. 10 A Let me make sure. I think that's it. 11 MR. HOPKIN: Okay. Why don't we go off the 12 record. 13 (A discussion was held off the record.) 14 (Exhibit Gates 2 identified.) 15 (Recess.) 16 BY MR. BAPTIST: 17 Q Right now we're looking at Exhibit Number 2, and 18 it is a drawing of the entities that Mr. Gates is 19 affiliated with, and I will let Mr. Gates explain what we 20 have in Exhibit 2. 21 A Okay. TFS Capital, LLC, that's a doing business 22 as name, a business who started 13 years ago when we didn't 23 know what the heck we were doing and we named the company 24 Technical Financial Services, and then we realized that was 25 a poor name for a company. So we reduced it to TFS 46 1 Capital. It's an SEC-registered investment advisor. 2 It provides -- it has four clients that it 3 manages money for: TFSMX, which is a quantitative 4 long/short equity mutual fund; TFSSX, which is a 5 quantitatively managed long-only mutual fund; and two hedge 6 funds or investment partnerships, Hunterized Capital 7 Partners, HCP, LLC, which is a Delaware-based limited 8 liability company for U.S. taxable moneys, and Hunterized 9 Global Partners, which is a Bermuda-based investment 10 company for non-U.S. investors or U.S. tax deferred moneys. 11 We also have another entity, Hunterized Fund of 12 Funds, which is basically personal moneys to reduce 13 conflicts in the business. Since we're in the investment 14 management space, we, from time to time, stumble on 15 exciting new things, and to prevent us from hoarding good 16 ideas and forcing us to share it with a group, we 17 basically, in addition to investing our personal moneys in 18 the funds alongside our clients, we have an obligation 19 internally dictated to keep 50 percent of our liquid net 20 worth in these four funds. 21 The extra moneys, to the extent that they exist, 22 we can invest in Hunterized Fund of Funds, which is a -- 23 basically a pooled investment where we have outside 24 managers, other investments and things like that. It owns 25 real estate. It has an investment in a partnership from 47 1 futures, guys who are trading futures down in 2 Charlottesville, Quantitative Investment Management. It's 3 got an investment in a small fund out in California where 4 guys are trading options, basically stuff that's not 5 correlated with what we're doing, a good way to diversify 6 personal moneys. 7 BY MR. HOPKIN: 8 Q If I can stop you there, several times in that 9 explanation you said "our money." I want to clarify who 10 you're referring to. 11 A That's fair. So we accept outside investors -- 12 well, we have outside investors in these four funds. 13 Q And you're referring to the two mutual funds and 14 the two hedge funds? 15 A Yeah, Hunterized Capital and Hunterized Global, 16 these four here. Those where we have -- we take outside 17 moneys to invest. 18 Q Just so you know, the dynamic we're struggling 19 with is that it is very helpful for you to point at the 20 exhibit, and I appreciate that, but -- 21 A I'm sorry. You're right. 22 Q -- that won't get reflected in the record. So I 23 have to say things like the two mutual funds or the two 24 hedge funds -- 25 A Just to be clear, the hedge fund is a generic 48 1 term and arguably could be applied to many different 2 entities here. Specifically, the TFS Market Neutral, the 3 TFS Small Cap, Hunterized Capital Partners and Hunterized 4 Global Partners. 5 Q Okay. 6 A So we manage outside moneys in those funds. In 7 aggregate, those funds have about $1.2 billion of assets 8 and deal exclusively in the equity markets. When I 9 referred to "our money," it's basically insiders at TFS or 10 close affiliates that we have, may have the option of 11 investing in Hunterized Fund of Funds. Anybody that we 12 want to -- if we find exciting opportunities, people can 13 have the option of investing in Hunterized Fund of Funds. 14 Hunterized Fund of Funds invests in other hedge funds. It 15 invests in real estate and things of that nature. 16 Q Okay. 17 A It also had engaged in the power markets since 18 2007, Hunterized Fund of Funds did. I'm sorry, Hunterized 19 Fund of Funds is already described on HFOF. So again, 20 internally, we stumble upon ideas, and we stumbled into the 21 electricity markets in '06 when somebody notified us -- we 22 had no idea that these things even existed. Somebody 23 notified us of it, and basically, it was a quantitative 24 analyst working at Dominion who was looking to leave 25 Dominion and wanted to work for a hedge fund. He knew 49 1 about us. He knew that we did quantitative modeling in the 2 equity markets, and he said there's synergies here. 3 Q Just to clarify, are the insiders at TFS also 4 the same insiders at HFOF and HEF? 5 A What's an "insider"? 6 Q Let me ask that in a different way. How are TFS 7 and HFOF and HEF related? 8 A HEF is owned by Hunterized Fund of Funds. 9 Q Who owns HFOF? 10 A Who currently owns Hunterized Fund of Funds? 11 Q Yes. The time period we're most primarily 12 concerned with is May 2010 through August 2010. So if your 13 answer would be different, I would like you to bear that in 14 mind. 15 A During that time period, it was the same 16 investors who were investing in Powhatan, myself and the 17 seven that I had named earlier. 18 Q I will ask one or two more questions, but I 19 don't want to get bogged down in this. How are HFOF and 20 TFS related? 21 A They are related in -- the members are largely 22 the same. The investors are largely the same. Plus, 23 they're related with this unique entity called Oakstone 24 that we have. Oakstone is a -- we found a special, unique 25 trading opportunity in the equity markets that requires its 50 1 own entity. For a whole host of different reasons, it 2 requires its own entity. So Hunterized Fund of Funds 3 invests in Oakstone, as do the two other hedge funds that 4 TFS manages, Hunterized Capital and Hunterized Global. 5 Q Let me ask you this: Who owns or controls HFOF? 6 A Larry, Rich, and I do. We are the controlling 7 entities. The other owners include the other five people 8 that I had mentioned earlier. 9 Q Are any of the entities on Exhibit 2 investment 10 advisors, whether or not they're registered with the SEC? 11 A TFS Capital is a registered investment advisor. 12 Q And TFS Capital is the entity depicted at the 13 very top of Exhibit 2? 14 A Yes. 15 Q Does TFS Capital advise HFOF? 16 A No. 17 Q Does HFOF have an investment advisor? 18 A It has three managing members: Larry, Rich, and 19 I. 20 Q But am I correct, then, that HFOF does not have 21 an outside investment advisor, regardless of whether that 22 advisor is registered with the SEC? 23 A It has investments with other outside managers, 24 to the extent you consider them investment advisors. 25 Q Okay. Do you have anything else you would like 51 1 to add to your description of Exhibit 2? 2 MR. BAPTIST: I have a few questions. 3 MR. O'DONNELL: Is that pending, or has that 4 been replaced? 5 MR. HOPKIN: Let's let him answer my question, 6 if you don't mind. 7 MR. BAPTIST: Okay. 8 MR. HOPKIN: Can you read my question back to 9 the witness, please. 10 (The reporter read the record as requested.) 11 THE WITNESS: Yes. 12 BY MR. HOPKIN: 13 Q Okay. Please continue, then. 14 A I'd like to talk a little bit about Moxy Vote, 15 if that's all right. Moxy Vote is a subsidiary of TFS. 16 It's wholly owned by TFS, and it's a way to empower the 17 retail shareholder to get more active in corporate 18 governance processes. 19 Q Okay. Anything else? 20 A Hunterized Energy Fund is wholly owned by 21 Hunterized Fund of Funds. Hunterized Energy Fund was not 22 engaged or involved in the electricity markets during the 23 time that Powhatan was involved. 24 Q When was HTF involved in the power markets? 25 A From, I believe, 2008 through early May 2010. 52 1 Q When did Powhatan start trading in the power 2 markets? 3 A May 30th, I believe. 4 Q So they nearly overlapped, but not quite; is 5 that fair? 6 A Less than a month. 7 Q Okay. Again, just continuing with the question, 8 do you have anything else to add, do you have anything else 9 you would like to draw our attention to on Exhibit 2? 10 A We didn't talk about the bottom half of the 11 exhibit. Does it make sense to talk about that? 12 MR. HOPKIN: Do you have questions about the 13 top? 14 MR. BAPTIST: Yes. 15 BY MR. BAPTIST: 16 Q You've drawn three different lines to Oakstone. 17 Can you explain the connection with the lines to Oakstone? 18 A Oakstone has three investors: Hunterized 19 Capital Partners, Hunterized Global Partners, and 20 Hunterized Fund of Funds. So it has three investors in it. 21 Q What type of entity is Oakstone? 22 A I believe an LLC. 23 Q Who are the members of Oakstone? 24 A I believe these three entities. 25 Q Is there a managing member of Oakstone? 53 1 A I believe it may be TFS Capital, but I'm not 2 certain. 3 BY MR. HOPKIN: 4 Q May I ask, do you have more formal documents, 5 aside from Exhibit 2, that may have been drawn up, for 6 example, by lawyers that you possess or control or have 7 access to? 8 A I don't think so. 9 Q Okay. 10 A One other thing that is noteworthy, there is 11 another entity on the top. It's a new partnership 12 established a couple of months ago called Penguin Lips, 13 LLC. It's a real estate holding company. TFS currently 14 leases its space, and we are buying a new office, and that 15 office will be owned by Penguin Lips. 16 Q I thought you were going to tell me Penguin Lips 17 was now a trading commodity at the NYMEX and you were -- 18 A No. 19 Q Okay. 20 A It's just to hold the office space in our West 21 Chester location. 22 BY MR. BAPTIST: 23 Q You said HFOF was engaged in power markets since 24 2006; is that correct? 25 A I don't believe that's correct. I don't believe 54 1 I said that. We became aware of the power markets in '06. 2 I think we first participated in the power markets in '07. 3 Q I wasn't clear on that. You said both 2007 and 4 2006. I wasn't sure -- 5 A It's somewhere around that time frame. 6 Q Who on behalf of HFOF engaged in the power 7 markets? 8 A We had various third-party traders who were 9 trading for us. HEEP Fund was one of them. We had a 10 relationship with -- I think he had an entity. His name is 11 Chuck Lubinski. He was trading for, I believe, either 12 Hunterized Fund of Funds or Hunterized Energy Fund -- I'm 13 not sure specifically -- in the New York ISO trading the 14 virtual markets. 15 We had a relationship with ThornWood Capital 16 Management, which was run by a gentleman named Ken Parkhill 17 in Chicago, who is trading monthly FTRs at MISO. We had a 18 relationship with a gentleman named David Nodine in 2007 19 where he was trading in the inc and dec market at PJM in 20 2007. 21 We had an internal -- again, TFS was hoping to 22 learn more about this space and get into it. We had a 23 gentleman -- I always forget how to pronounce his name, but 24 Krishna Sinha, who had worked for Koch Industries down in 25 Houston, that wanted to come and teach us how to trade inc 55 1 and dec markets at PJM, so he was doing that as an employee 2 of TFS. Everybody else was a third party relationship. 3 BY MR. HOPKIN: 4 Q Can you clarify who he was trying to teach how 5 to trade in PJM? 6 A He was teaching me. He was teaching my 7 associate, Chao Chen. 8 Q Okay. And were up-to congestion transactions 9 covered in what you learned? 10 A I believe they were discussed. I believe, 11 though, that it was our initiating those discussions. He 12 was teaching us -- he had developed, I guess, a load 13 forecast model that he promised us would work, and he could 14 trade effectively in the markets. 15 BY MR. BAPTIST: 16 Q When was this? 17 A Krishna was -- Krishna, we had to apply for an 18 H-1B visa for Krishna. I believe that was 2008. October 19 of '08 was when it was approved, I believe. 20 Q Does HFOF still engage in power markets? 21 A No. 22 Q When did it stop engaging in power markets? 23 A Beginning of May of 2010. 24 BY MR. HOPKIN: 25 Q Is your answer the same for HEF? 56 1 A Yes. 2 BY MR. BAPTIST: 3 Q Do you recall when HFOF engaged HEEP Fund for 4 power market trading? 5 A 2008, I believe June of 2008. 6 Q Do you have anything else to add to the top of 7 Exhibit 2? 8 A I'd love to spend more time talking about Moxy 9 Vote, but you probably don't want to hear about that. 10 Q Is there a patent associated with Moxy Vote? 11 A Pending. 12 Q Pending? 13 A Yeah. I guess just noteworthy, Krishna no 14 longer works with TFS. His trading was largely 15 unsuccessful. 16 Q Can you discuss the bottom half of Exhibit 2, 17 please? 18 A Certainly. Because we perceived the power 19 markets to be -- to contain a huge element of risk and 20 uncertainty, this was an area that we weren't as 21 knowledgeable about as some of our other investments that 22 we owned in Hunterized Fund of Funds, and therefore, there 23 was a different risk tolerance of the investors. Some 24 people were more comfortable; some people were less 25 comfortable. Plus, for operational reasons, it was easier 57 1 to spin these off. 2 Earlier this year, three new entities were 3 created: LSE Capital Management, which is -- I'm a vice 4 president of LSE Capital Management. Larry Eiben is the 5 only member of LSE Capital Management. LSE Capital 6 Management is a -- the managing member of two other 7 entities, Powhatan Energy Fund, LLC, which we've discussed 8 earlier, and Tuckahoe Energy Fund, LLC. 9 BY MR. HOPKIN: 10 Q Is that after Tuckahoe, New Jersey? 11 A I don't know. 12 MR. TABACKMAN: Powhatan and Tuckahoe are big 13 names around the Virginia area. 14 BY MR. BAPTIST: 15 Q When was LSE Capital Management formed? 16 A Earlier this year, Larry had created the entity. 17 I suspect he could give you the specific dates, but my 18 intuition tells me February, March-ish of this year. 19 Q When was Powhatan created? 20 A Around the same time. 21 Q And how about Tuckahoe? 22 A Around the same time. 23 Q How is LSE Capital Management related to TFS 24 Capital, if at all? 25 A The relationship -- the only relationship that I 58 1 know is that the investors of -- they're similar employees. 2 The managing member of LSE Capital Management is also an 3 owner of TFS, and two of the three vice presidents of LSE 4 are owners of TFS, and the third is the accountant for TFS. 5 Q Do you have anything else to add to Exhibit 6 Number 2 that would help explain the structure of TFS and 7 how it relates to Powhatan? 8 A I'd like to spend a little bit of time talking 9 about Tuckahoe, if that's all right. 10 Q Sure. 11 A Tuckahoe is a member of MISO that was 12 established earlier this year. It was established for a 13 relationship similar to Powhatan where we had found a 14 third-party trader who we thought was trading personal 15 moneys, and we said if you're trading your personal 16 moneys -- we had had a relationship with him in Hunterized 17 Fund of Funds, and we said we would like to structure it a 18 little bit differently, can you trade the monthly FTRs at 19 MISO for Tuckahoe. 20 Again, I forget the specific dates, but it was 21 applied for a membership and was approved earlier this 22 year. The account was funded, the Black Rock account was 23 funded, and the systems were set up, and then the trader 24 got cold feet. He had some drawdowns in this account 25 alongside with other accounts, and said I can't handle this 59 1 risk, I don't want to trade my money anymore, but I would 2 be happy to trade Tuckahoe. 3 And we said no, if you're not comfortable with 4 your own money, we're not comfortable with you trading our 5 money. So it is still a member of MISO, has been largely 6 dormant. 7 Q Who was this third-party trader? 8 A ThornWood Capital Management, Ken Parkhill. 9 BY MR. HOPKIN: 10 Q Just one or two more quick questions. Am I 11 correct that LSE Capital Managed is organized as a limited 12 liability company? 13 A Yes. 14 Q Other than what we've just discussed, are there 15 any other relationships that would connect the three 16 entities in the bottom half of Exhibit 2 with any of the 17 entities represented in the top half of Exhibit 2? 18 A And can you remind me of the parallels that I 19 previously drew? 20 Q I believe you described there was a relationship 21 with HFOF. Do you remember that? 22 A If it's all right, maybe I can just try to start 23 from scratch and just define all of the relationships that 24 I'm aware of between these entities. 25 MR. HOPKIN: Why don't we come back to that 60 1 later. 2 MR. BAPTIST: We can put that exhibit away for 3 now. 4 BY MR. HOPKIN: 5 Q One more question. You don't need the exhibit 6 in front of you. Can you tell me what power products HFOF 7 traded between 2007 and May of 2010? 8 A Hunterized Fund of Funds or Hunterized Energy 9 Fund, I believe, traded up-to congestion market at PJM, 10 traded incs and decs at PJM. It traded monthly FTRs at 11 MISO. It traded New York ISO incs and decs and, I believe, 12 had a little exposure to New England ISO incs and decs. 13 Q Were you able to follow or monitor that trading, 14 you personally? 15 A To some degree, to various degrees, yes. 16 Q Can you describe that for me? 17 A It had different traders trading on its behalf. 18 One of those traders was internal. That was a short-lived 19 relationship. But the other traders were generally 20 third-party traders that we had set up an advisory 21 agreement with where they were the experts and we were just 22 investing to gain exposure to their trading of their 23 personal moneys. Some of these traders -- they all gave us 24 some degree of explanation in terms of what their trade 25 was, what their edge was, the risk returns of the 61 1 marketplace. Some of them gave more transparency than 2 others. 3 Q Is it fair to say that -- strike that. 4 What kind of -- when traders provided these 5 explanations of strategies and their edge, as you've put 6 it, were you able to understand and follow the explanations 7 they were providing? 8 A We definitely understood them or felt 9 comfortable enough with them, or we wouldn't have invested 10 with them. Did we understand -- but we had a thirst for 11 knowledge, and I think what I had said earlier as it 12 relates to Alan probably applies to all of these guys. We 13 wanted more information. 14 Q Is that tension or dynamic, wanting more 15 information and the trader you're dealing with maybe 16 pushing back a little bit, is that common in your business? 17 A That is common, for us at least. I don't know 18 for others. 19 MR. HOPKIN: All right. 20 BY MR. BAPTIST: 21 Q Do you personally have experience in power 22 trading? 23 A I've never traded in the power markets. I've 24 never worked for a utility. I took physics 101 and learned 25 electricity a little bit and disliked every moment of it. 62 1 I was involved to various degrees with each of these 2 traders and discussing with them their strategy, the 3 opportunities, and how to improve. 4 But I first became aware of these markets in 5 2006, had no idea that they existed, and this has been much 6 in the -- my involvement in these markets has probably been 7 in the same way as the average investor's involvement in 8 the stock market or their knowledge of the mutual funds. I 9 had a day job that was distinct and different from the 10 power markets that involved most of my time, much in the 11 way that an average investor has ideas or thoughts or gets 12 involved in reading Money Magazine and learning about 13 mutual funds. That is what I would describe my 14 relationship with the power markets as. 15 Q Where did you work before you were employed by 16 TFS Capital? 17 A Immediately prior, I was working at a database 18 software company, Customer Insight, which was later bought 19 out by Experian. 20 Q How long did you work there for? 21 A Two years, two or three years. 22 Q What were the dates on that? 23 A '96 to '99. 24 Q Do you know what an up-to congestion transaction 25 is? 63 1 A I'm not an expert, but I'm aware of some of the 2 mechanics of the trade. 3 Q Can you explain your understanding of the 4 mechanics? 5 A Well, the up-to congestion market involves 6 various components. It involves an interface -- I believe 7 it to be specific to PJM. It involves an interface. It 8 involves one or two nodes maybe in the market. It involves 9 day-ahead versus real-time settlements. It involves fixed 10 costs associated with putting on the trade. I'm not sure 11 if -- they may be referred to as operating costs. It 12 involves reserving transmission through OASIS, which also 13 involves a fixed cost. And I guess recently during this 14 time period, it involved a transmission loss credit. 15 Q When you say "this time period," what do you 16 mean? 17 A From May of 2008 through -- excuse me. May of 18 2010 through August of 2010, this time period that Powhatan 19 was involved in these markets. 20 Q And during that time period, Powhatan made up-to 21 congestion transactions; correct? 22 A I believe -- I never independently verified it, 23 but that was my understanding, that that's exactly what 24 HEEP did on behalf of Powhatan. 25 Q HEEP was primarily responsible for the up-to 64 1 congestion transactions on behalf of Powhatan in PJM from 2 May 2010 through August 2010? 3 A I would say it was exclusively responsible for 4 the trades. 5 Q So no one else on behalf of Powhatan made up-to 6 congestion transactions in PJM during this time period? 7 A That's true. 8 Q And this was according to an agreement between 9 HEEP and Powhatan? 10 A Yes. 11 Q When was this agreement executed? 12 A Probably April of this year. 13 Q Who negotiated this agreement? 14 A I think there were various parties who were 15 involved to various degrees, but primarily Alan Chen and 16 myself. 17 Q Who actually signed the agreement? 18 A I believe Alan Chen and myself, but I know Alan 19 Chen, I think myself, but it's a possible that Larry could 20 have signed on behalf of Powhatan. 21 Q Are there any prior iterations of this agreement 22 with Powhatan or any other entity affiliated with TFS 23 Capital? 24 A Hunterized Energy Fund had a relationship with 25 Powhatan -- with HEEP from 2008 through the beginning of 65 1 2010 where it was involved in up-to congestion trading. So 2 it was based upon a clearly defined relationship. 3 Q Was this relationship defined in the agreement? 4 A Yes. 5 BY MR. HOPKIN: 6 Q I believe Erik's question was more pointedly 7 directed as to whether there -- were there drafts of this 8 agreement prior to the one that you and Mr. Chen executed 9 on behalf of Powhatan and HEEP? 10 A I believe it to be a very iterative process, 11 yes. There was negotiation back and forth. 12 BY MR. BAPTIST: 13 Q And can you discuss the terms of this agreement? 14 When I say "this agreement," the agreement between Powhatan 15 and HEEP. 16 A It's a three-page document that basically -- the 17 title of the document is "Advisory Agreement" where HEEP 18 was granted authority to trade by Powhatan to trade on its 19 behalf in the PJM markets, and its obligation was to notify 20 us of issues, conflicts, problems. It was obligated to 21 trade our moneys alongside its own moneys, but with just a 22 different factor. During the -- I believe during the 23 extent of this relationship, the ratio was to find 20 X. 24 So for every megawatt that HEEP put on for its own account, 25 it put on 20 megawatts in Powhatan's -- excuse me. Every 66 1 megawatt that it bid in for its own account, it bid in 20 2 megawatts for Powhatan's account. That was its objective. 3 Certainly, all of the various operational reasons, it 4 didn't always play out that way, and due to the nature of 5 the clearing process or the auction, that's not necessarily 6 how the trade settled. 7 BY MR. HOPKIN: 8 Q What was the purpose of establishing that ratio? 9 A To provide guidance or structure to Alan in 10 terms of -- to set his expectations in terms of how we 11 wanted the account managed. 12 Q Let me try a different question. Did you 13 want -- strike that. 14 In terms of the value at risked that Mr. Chen 15 was trading on behalf of HEEP versus the value at risk he 16 was trading on behalf of Powhatan, is it fair to say that 17 the value at risk Mr. Chen was trading for Powhatan was 18 significantly larger than for HEEP? 19 A I believe specifically -- it was 20 X that 20 amount. 21 Q And was that ratio reflective of the fact that 22 you simply had more funds to allow Mr. Chen access to and 23 to trade with? 24 A I suspect funds or just risk tolerance played a 25 factor into it as well. 67 1 MR. HOPKIN: Okay. 2 BY MR. TABACKMAN: 3 Q Who decided on that ratio? How was that ratio 4 arrived at? 5 A The ratio was arrived at -- it wasn't -- it was 6 subject to change. That's how it was set up originally. 7 But the agreement has different terms. So his payout as a 8 function of trading profits varied as a function of the 9 ratio. We were incented to increase the ratio because then 10 we would pay him a smaller percentage of the profits. The 11 ratio was a function of our risk tolerance, our perception 12 of the risk, return of the trade, its correlation to other 13 investments. It was a function of his assessment of the 14 ability of the market to handle this type of activity. 15 Q I mean, but was it a number that you arrived at 16 through collaboration, sitting down and talking about it 17 amongst you, or did you dictate that number to him? 18 A No, it was a collaborative process, but at the 19 end of the day, in many ways it feels like an arbitrary 20 number that we just pulled out, but it was certainly 21 collaborative, but we could have had the same process and 22 come up with a different result. 23 Q I understand. 24 BY MR. BAPTIST: 25 Q How was HEEP compensated under the agreement? 68 1 A HEEP was paid 20 percent of the profits that it 2 made in our account, excluding certain items like default 3 allocations, like membership fees, and things like that. 4 Q So it was an incentive-based compensation? 5 A Yes. 6 Q Were there any fees associated with the 7 agreement with HEEP? 8 A I don't understand the question. 9 Q Did HEEP charge any fees associated with the 10 trades it was making on behalf of Powhatan? 11 A Were there any fixed -- 12 Q Yes, any fixed fees. 13 A Any fixed fees, no. It was a performance-based 14 arrangement. 15 Q Are there any time limits on this agreement, as 16 in, is there a certain starting and stopping point for HEEP 17 to trade on behalf of Powhatan? 18 A I suspect the starting -- I don't know what's 19 actually in the agreement, but the starting date is 20 probably like the date that the agreement it was signed. 21 It was signed before the operations were set up. I don't 22 believe there was a clear ending date, but the payouts, 23 there was a clearly defined schedule in terms of when the 24 payouts would occur. 25 Q Does Powhatan still have this contract in its 69 1 possession? 2 A Yes. 3 Q We will likely issue a data request asking to 4 look at it at some point. 5 How did Powhatan come into contact with HEEP? 6 A How did Powhatan? Powhatan -- 7 Q Let me rephrase the question. Maybe this will 8 help: Why did Powhatan choose to have HEEP trade on its 9 behalf in PJM? 10 A Because some of the members in the management at 11 Powhatan had a prior relationship with Alan. We had met 12 with Alan in the past, felt very comfortable that he had a 13 lot of experience in the industry or in this space. He was 14 trading his personal moneys alongside this, and we felt 15 comforted knowing if he was willing to risk his personal 16 moneys, we're willing to go along for the ride with our 17 personal moneys in this space. We had done, I suspect, 18 some standard due diligence with background checks and 19 general research on him. We, obviously, reviewed his 20 resume, things of that nature. 21 Q What kind of say did Powhatan have with regards 22 to the trades that HEEP was making on Powhatan's behalf? 23 A When you say what type of say, what specifically 24 do you mean? 25 Q Did HEEP have to receive approval from Powhatan 70 1 before it made trades specific to the up-to congestion 2 transactions in PJM? 3 A Beyond having a signed agreement in place, no. 4 We had a signed advisory agreement where we granted him 5 authorization to act in our place, in our stead to execute 6 trades. Once that was in place, no. 7 Q Did Dr. Chen ever consult with Powhatan before 8 HEEP made transactions on behalf of Powhatan? 9 A Yes. The -- yes. 10 Q Can you explain? 11 A We had a significant drawdown -- several 12 significant drawdowns during the relationship with Powhatan 13 where they were significantly losing trades. We had 14 discussions with Alan about our risk tolerance and our 15 concern with the market and trying to understand the risks 16 involved. So those discussions I suspect Alan may have 17 interpreted as we had a lower risk tolerance than he may 18 have otherwise thought, at least during that shortened time 19 period, or that we were less comfortable with the risks 20 that were introduced into the fund. 21 BY MR. HOPKIN: 22 Q What do you mean by the term "drawdown"? 23 A I'm sorry. A loss of capital of a fund. 24 Q Let me tease that apart. I'm a layman, but I've 25 heard "drawdown" used in the context of investors deciding 71 1 to pull their money out of a fund. I just want to 2 understand more specifically how you're using that term. 3 A A drawdown of performance specifically. So if 4 you were to calculate the P&L on a percentage basis, it was 5 up 2 percent today, down 5 percent tomorrow, up the next 6 day, just tracking the percent gain or loss over a time. I 7 am referring to the term "drawdown" as a significant 8 decline in the value as a result of trading losses. 9 MR. HOPKIN: Thank you. 10 MR. TABACKMAN: Can I ask a question? 11 MR. HOPKIN: Sure. 12 BY MR. TABACKMAN: 13 Q I'm trying to get a fix on the degree of 14 discretion Mr. Chen had. I know on the equity side of 15 things, if you're representing other people's money, you 16 have discretionary authority or you might have to go back 17 to your investor every time you want to make an investment 18 for them. 19 Where does Mr. Chen -- is there something 20 analogous in that world to the kind of authority that 21 Mr. Chen had with respect to doing trades on behalf of 22 Powhatan? 23 A He had a limited power of attorney to act in 24 Powhatan's place. 25 Q He didn't have to come to you every time he 72 1 wanted to do a trade, whether it was to get specific 2 authorization, I take it? 3 A No. 4 BY MR. HOPKIN: 5 Q Is there any trading that Mr. Chen would have or 6 did engage in that would have or could have triggered him 7 to come to you and ask for specific authority to engage in 8 the trade? 9 A To the extent he wanted to do a trade that was 10 inconsistent with the advisory agreement we had in place, I 11 hope he would consult with us. 12 Q Did he ever, in fact, consult you and seek your 13 specific permission before entering into a trade? 14 A No. 15 BY MR. TABACKMAN: 16 Q Who was among the folks in TFS who knew Mr. Chen 17 had a relationship? If this has been covered, I will 18 withdraw it. Who developed a relationship with Mr. Chen 19 first of you, and I guess it's your brother, and Mr. Eiben, 20 or is it someone else who knew Mr. Chen to make the 21 suggestion that he be the person to do this? 22 A I think the relationship began in 2007, 23 beginning in 2008 when Larry Eiben cold called Alan Chen. 24 Q Do you know how Mr. Eiben learned of Mr. Chen at 25 all even to call him? 73 1 A PJM's membership list. 2 Q Was there anyone else that was contacted as a 3 possibility or considered as a possibility for a 4 relationship other than Dr. Chen? 5 A Yes, there were other people. 6 Q And what was the process that you went through 7 in selecting Dr. Chen? Did you participate in that? 8 A Yes. 9 Q Could you describe the process that you went 10 through in selecting the person, Dr. Chen, as opposed to 11 others? 12 A To clarify, we selected Alan in addition to 13 others. So everybody wasn't just vying for one 14 opportunity. We had had other relationships with other 15 traders as well. 16 The way that we chose to engage or pursue the 17 relationship with Alan was based upon an assessment of his 18 knowledge of the space, his experience of the space, the 19 fact that he was trading significant personal moneys in the 20 space, that we're not experts here, and one way that we try 21 to control our risk is by ensuring that our traders are 22 trading personal moneys. If it's just a performance-based 23 relationship, it turns out to be heads I win, tails you 24 lose, we didn't want that. We wanted him to have skin in 25 the game. So it was very comforting to know that he was 74 1 trading this with his own personal money. 2 BY MR. BAPTIST: 3 Q I want to go back to that June 25th, 2010, 4 meeting that Powhatan had with Dr. Chen. 5 A Uh-huh. 6 Q What strategies specifically did Dr. Chen share 7 with Powhatan at that time? 8 A When you say "strategies," what does that mean? 9 Q I seem to recall that you testified that he 10 shared some type of trading strategies with you. Correct 11 me if I'm wrong. 12 A I'm guessing you're right, but I don't know. We 13 spoke about the up-to congestion trade. We talked about 14 the new dynamics with the transmission loss credit being 15 involved, the new allocation. We discussed the risks 16 associated with the trade, the economic benefit to the 17 marketplace of our paying a fixed fee to the marketplace. 18 We discussed the risks of a leg of a trade not being 19 accepted into the marketplace. So strategies as it relates 20 to that, but we also spoke about other opportunities. I'm 21 sure I asked at one point, Alan, why don't you trade FTRs 22 for us or why don't you come to West Chester and let's 23 create a desk. 24 Q Can you expand on Dr. Chen's strategies 25 specifically relating to the up-to congestion transactions 75 1 in PJM during June 2010 through August 2010? 2 A His strategy, as I recall, was to try to provide 3 attractive risk-adjusted returns to make money in the 4 account without minimizing significant drawdowns. His 5 objective was to reduce risk in the account by ensuring 6 that his modeling -- I guess focusing on the modeling to 7 ensure that both legs of the trade were accepted, to 8 understand the pricing or the nodal risk within the market, 9 and to model the uncertainty of the transmission loss 10 credit or the potential payout. 11 MR. BAPTIST: Can you read that answer back to 12 me again, please. 13 (The reporter read the record as requested.) 14 BY MR. BAPTIST: 15 Q Can you expand on that last point about the 16 transmission loss credit payout? What was -- how was his 17 objective achieved by looking at that one factor? 18 A I don't think his objective was achieved by 19 looking at the one factor. He looked at that factor in 20 conjunction with all of the other risks and dynamics in the 21 marketplace to achieve his objective. I don't think it 22 would be possible to say he achieved any objective by 23 looking at only one of the many moving parts within the 24 trade. 25 Q What did Dr. Chen tell you about the 76 1 transmission loss credit payout? 2 A He indicated that it was new to the marketplace 3 or relatively new to the marketplace. He indicated that it 4 was uncertain and unknown and difficult to predict, but 5 that it changed the risk return of the marketplace. 6 BY MR. TABACKMAN: 7 Q How did it do that? 8 A Made it more attractive. 9 Q In what way? 10 A Increased return and/or lowered risk. 11 Q How did it increase return? What was your 12 understanding of what he told you? 13 A It increased return because there was now an 14 unknown payout to the trade that would make certain 15 trades -- well, there's an additional payout to the trade 16 that didn't previously exist. 17 Q And how did that fit into -- when he was talking 18 to you and telling you about his overall objective, how did 19 that piece of it fit into, as you recall, the overall 20 strategy? 21 A That was -- that particular component -- we had 22 had a relationship with him for a while where that 23 component didn't exist. So to isolate that particular 24 component, again that made it more attractive on a risk 25 return basis. 77 1 Q What was your understanding of how the 2 transmission loss -- this factor, how did it work? How did 3 that -- what was going to happen, this new factor that came 4 in, as he explained it to you? 5 A I have limited knowledge about it. Again, I'm 6 not an expert in this space, but my understanding was that 7 participants in the up-to congestion market, all 8 participants, I suspect, all of those, even though they're 9 not subject to this investigation, were receiving 10 transmission -- credits for transmission losses on the 11 system. So anybody who accepted transmission through OASIS 12 was able to participate in recouping the costs associated 13 with that. 14 Q Did he tell you -- did he give you an 15 understanding of how that came to be, what was his 16 understanding of why this new factor came in? 17 A I don't recall, but I had some background 18 knowledge about it. I'm not sure if it came from Alan or 19 from others. 20 Q What was that knowledge? 21 A That there was some debate last year, that 22 various parties, including possibly Black Oak Energy, were 23 involved in a debate in terms of how to allocate these 24 transmission loss credits in the fall or winter of last 25 year, that the up-to congestion participants would be able 78 1 to participant. 2 Q Anything else that you can recall he told you 3 about the impact of this transmission loss credit on his 4 trading strategies or choice of trades to engage in? 5 A I know that he expected that this was directly 6 related to the increased volume that Powhatan engaged in 7 was related to the transmission loss credit allocation. 8 Q Is that because the transmission loss credit, 9 what you said before, made these kinds of trades 10 potentially more attractive, changed the risk? 11 A It may be a trade that affected the specific 12 trades that he put on as well. So all else being equal, 13 assuming the same trades, it made it a good bit more 14 attractive. But I think also to various degrees, it 15 affected his trading behavior. 16 Q And what was your understanding of why that was, 17 why that affected his trading behavior? 18 A Because he was trying to increase the bet that 19 the transmission loss credit would be greater than all of 20 the fixed costs associated with putting on the trade. 21 Q Let me see if I understand it. Are you saying 22 at some point or some number of points, you had one or more 23 conversations where he talked about the possibility of the 24 transmission loss credit exceeding the fixed cost of the 25 trade? 79 1 A Yes. He wasn't guaranteeing anything. 2 Q I understand that. 3 A He said this is a different bet that we can now 4 introduce into the portfolio. There's risk associated with 5 all my bets, this one included, and this is a way to 6 diversify the risks within the fund by introducing that 7 risk. His objective, I believe, in managing the fund was 8 to diversify our risks with the objective of producing 9 risk-adjusted returns. This was another mechanism for him 10 to introduce a different risk into the portfolio. 11 Q And that different risk was? Is that the up-to 12 transactions or? 13 A His altering of the trading with the increased 14 volumes. 15 BY MR. BAPTIST: 16 Q When you say "increased volumes," do you mean 17 transmission? What do you mean by that? 18 A I don't know. I think I mean transmission. 19 BY MR. HOPKIN: 20 Q Do you mean increased volumes of just up-to 21 transactions themselves, more of them? 22 A Yes, which I believe includes transmission. 23 BY MR. TABACKMAN: 24 Q Are you talking about more megawatt-hours per se 25 or just a greater number of transactions or -- I mean, 80 1 which I understand can overlap. They're not discrete 2 concepts, I understand. But -- 3 A I was referring to megawatt-hours, but it may 4 have been distinct trades as well. I don't know. 5 BY MR. HOPKIN: 6 Q Do you know how -- are you aware of any 7 relationship between the success of the trade and the 8 volumes associated with the trade? 9 A The increased volumes of the trade, I believe, 10 were associated with a different trading strategy that Alan 11 introduced into the fund. So he had one or two or whatever 12 strategies in the fund. I believe he may have introduced 13 another strategy into the fund. All in, I believe that 14 that enhanced the expected risk-adjusted return, again 15 because he was introducing another risk into the fund, 16 which helped the fund naturally diversify. 17 Q And I guess the risk -- I understand what you're 18 saying, the risk profile of the fund and so forth, and this 19 was helpful to you. But we're more directly concerned 20 with, was the risk actually associated just with the up-to 21 congestion transactions? 22 A Compared to the high-volume up-to congestion 23 compared to not-high-volume risk -- 24 Q Whether or not -- let me just ask a question, 25 and we will take it from there. What were the -- with 81 1 regard to the -- strike that. 2 Did he give a name to this strategy, or how did 3 you refer to it in conversation? 4 A Which strategy? 5 Q The increased volumes of up-to congestion 6 transactions associated with -- 7 A I believe we referred to them as increased 8 volume up-to congestion transactions. 9 Q Okay. Did he describe to you the relative risk 10 level associated with those transactions? 11 A Relative to which transactions? 12 Q Just generally, did he describe these as 13 high-risk transactions, high risk, high reward, low risk, 14 low reward, low risk, high reward, something like that? 15 A I don't recall how he specifically described 16 them. I know how he perceived them, and I perceived them 17 to be high risk, high return strategies. 18 Q What caused you to reach that conclusion? 19 A General uncertainty in the marketplace, the fact 20 that there was a fixed payment being made, multiple fixed 21 payments being made with an uncertain outcome, the fact 22 that the volumes were -- I knew that the biggest risk, I 23 believe, that he described was the bidding risk. 24 When the up-to congestion trade takes place, 25 there are two risks -- well, you have to reserve 82 1 transmission through OASIS and then participate in the 2 day-ahead energy market. Those two legs are bid into the 3 marketplace and into the auction and weren't guaranteed to 4 be accepted. So you can desire to put on a better position 5 and all of a sudden half of it is off. So it changed 6 significantly. So I perceive that -- and that risk, 7 obviously, gets exacerbated with the higher volumes. 8 Q Are you aware of any way that you could mitigate 9 or eliminate those risks, the risk of not being accepted? 10 A I believe that's probably all participants in 11 the market, that was a risk that they were concerned with 12 and were trying to mitigate or eliminate or assess. 13 BY MR. TABACKMAN: 14 Q Right. And I guess a question is, did he 15 discuss that with you how he might do that or how he 16 planned to do that? 17 A How he may do that? 18 BY MR. HOPKIN: 19 Q Let me ask another question. With regard to the 20 risk that one or both legs would not be accepted, did he 21 discuss with you any way that he might mitigate that risk, 22 that a leg would not be accepted? 23 A I believe he told us that's one reason why you 24 have to keep volumes, instead of going to 100 X versus 20 25 X, I believe the relatively low volumes that we were 83 1 participating in. I believe that he was modeling. I 2 believe that the risk was directly associated with the 3 relative prices of the day-ahead market. 4 And I believe that he did modeling to assess the 5 likelihood of there being separation in the day-ahead 6 markets that would make it so that these -- so that they 7 would be accepted. So he basically modeled the day-ahead 8 market and tried to assess situations to keep that risk -- 9 to minimize that risk or to try to help minimize that risk. 10 Q Do you have an opinion as to whether or not 11 Dr. Chen was successful in mitigating that risk? 12 A I don't know. I have conflicting opinions. I 13 think he probably largely was successful, but I'm not sure 14 how he would assign all of his losses. I believe he, in a 15 recent -- in a more recent e-mail exchange that I had had 16 with him, I guess after receiving a letter from you guys 17 and prior to engaging Earle and his team, I had had 18 discussions with him, asking him to assess these risks. 19 And I believe -- it's not clear to me at least 20 in his e-mail, but I believe his e-mail said he was 21 successful in reducing -- in not incurring this risk. But 22 that was a short time period. Anything could happen, and 23 had the relationship continued, this would be a risk that 24 still would have kept me up at night. 25 Q Are you aware of whether or not, when Dr. Chen 84 1 was engaging in these transactions, that he, in fact, had 2 one or both legs of any of these transactions not be 3 accepted? 4 A Can you repeat that question? 5 MR. HOPKIN: Sure. I would ask the court 6 reporter to, please, read it back. 7 (The reporter read the record as requested.) 8 THE WITNESS: I'm not aware specifically of any 9 time that he had a leg rejected. 10 BY MR. HOPKIN: 11 Q Do you have anything else you would like to add 12 to that answer? 13 A Again, just to reiterate what I said before, 14 that that is still a perceived risk. I work in the equity 15 markets. If the credit crisis told me anything, it's 16 you've got to assume that the worst-case scenario can 17 happen. There were many investment banks for decades said 18 we can take increased leverage, it'll never happen, and 19 then one day everything happened when Lehman went under. 20 This is a risk that may not have been realized during this 21 time period was a risk that I was very concerned with, 22 aware of, and perceived to be to lose significant moneys. 23 Q Are you aware of whether or not any of the up-to 24 congestion transactions Dr. Chen engaged in on behalf of 25 Powhatan were offsetting? 85 1 A What does "offsetting" mean? 2 Q Sure. By "offsetting," I mean for example you 3 had up-to transactions where you had -- that -- I tell you 4 what. Why don't I come back to that. 5 BY MR. BAPTIST: 6 Q You stated that you had conflicting opinions 7 regarding the success of these transactions. Can you 8 expand on those conflicting opinions? 9 A Can we put that statement in context? Can we go 10 back? 11 MR. BAPTIST: Can we read the question and 12 answer where he discussed conflicting opinions. 13 (The reporter read the record as requested.) 14 THE WITNESS: The conflicting risks, I thought 15 that many of the -- some of the drawdowns that we had may 16 have been attributable to this risk of a leg not being put 17 on, but more recently believed that that may have been not 18 associated with that. 19 MR. BAPTIST: Okay. 20 BY MR. HOPKIN: 21 Q Regarding the June 25th meeting you had with 22 Dr. Chen where you discussed the strategy of increased 23 trading volumes and up-to congestion transactions in PJM, 24 do you have any notes relating to that meeting? 25 A No, none that I can find. 86 1 Q Do you know if any of your co-workers have notes 2 relating to that meeting? 3 A I don't believe that we do. 4 Q Do you know if you wrote any e-mails relating to 5 that meeting? 6 A I'm sure there were logistical e-mails relating 7 to that meeting and things of that nature. 8 Q Nothing of substance? 9 A I don't think so, but the answer is I don't 10 know. 11 BY MR. BAPTIST: 12 Q Did Dr. Chen provide any documents for Powhatan 13 to see? 14 A Can you repeat that question? Did he produce 15 any documents? 16 Q Did he produce or present any documents at this 17 meeting? 18 A He didn't craft any documents or prepare them 19 himself, but I believe he showed me documentation from the 20 PJM Web site talking about the up-to congestion trading 21 generally. He produced -- he helped us log on to the 22 account and poked around and showed us where all the data 23 is and kind of gave us an explanation of how it worked. I 24 believe we might have stumbled into some documents there. 25 BY MR. HOPKIN: 87 1 Q Did -- at any point did you discuss the success 2 of the trading strategy with Dr. Chen? 3 A Yes. 4 Q And when was that? 5 A Almost continuously we had dialogue relating to 6 the -- he was sending us daily statements, which quantified 7 the success or lack thereof. 8 Q How would you describe the success of the 9 high-volume up-to congestion transaction trading strategy? 10 A It depends upon how you define "success." I 11 suspect these trades largely are resulting in the 12 discussion that we're having today, which I've enjoyed it, 13 but it's not what I otherwise would have chosen to do 14 today. So I would say that that's a drawdown of our 15 involvement. I would say that the -- as I understand it, 16 the trade, it was a nice complement to the fund. 17 Our involvement with Alan has incurred 18 significant risk. There were days where we lost a lot of 19 money, but net net profitable for us. But I don't know 20 that that -- that to be specific to Alan's high-volume 21 trades. I have seen documentation and have spoken with 22 others in the marketplace who have shown me very compelling 23 numbers from up-to congestion traded that I don't believe 24 is predicated on the high volume. 25 Q Let me ask a similar question, and it's a little 88 1 bit more pointed. Did you ever specifically discuss with 2 Dr. Chen the profitability of it is high-volume up-to 3 congestion transactions in PJM on a stand-alone basis? Do 4 you understand my question? 5 A I'm not sure I fully understand. 6 Q Sure. Let me just tease it out a little bit 7 more. In other words, what I'm hearing back from you is 8 that the strategy provided benefits to you in several 9 different ways, including diversifying your risk profile -- 10 A Uh-huh. 11 Q -- and things of that sort. 12 A Uh-huh. 13 Q My question is specifically to the profitability 14 on a stand-alone basis of just the trades associated with 15 the high-volume up-to congestion strategy. Did you ever 16 discuss the profitability of those trades on a stand-alone 17 basis with Dr. Chen? 18 A I don't recall specifically, but I suspect that 19 those trades were described as on a stand-alone basis as 20 having an attractive risk -- an expected return. 21 Q What do you mean by "attractive"? 22 A They were good enough to justify being used in 23 the account. 24 Q What's your standard for that? 25 A It's tough. We don't have a -- it's very 89 1 subjective, at least from our standpoint, and we were 2 largely out of control here, not trading the account. But 3 we were allowing him to do that -- there are different ways 4 you can assess it. Clearly on a quantitative basis, the 5 daily P&L, you could look at it that way. You could 6 qualitatively try to assess the risks and does the expected 7 return justify assuming those risks. 8 We never did that specific -- I don't recall -- 9 our conversations with Alan were largely about trading in 10 aggregate, and I understand there were other trades done, 11 and this is one component of the portfolio. 12 Q When you say "this," you mean that one 13 particular strategy? 14 A The high-volume trades. 15 BY MR. BAPTIST: 16 Q You said they had an attractive expected return. 17 What was the expected return? 18 A It's hard to quantify. My sense would be 25 19 cents a megawatt, 25, 35 cents, rough, rough numbers, I 20 believe. I would have to go back and check. I think that 21 Alan said that -- you know, in our mind, we set up this 22 account with the expectation that we could lose it all. 23 That was what we perceived to be the downside of his 24 trading. He also led us to believe that even after his 25 fees that it would be possible to double our money in a 90 1 year or 100 or 200 percent in a year. So on an aggregate 2 level, that's how we looked at it, but high risk, high 3 return type of strategy. 4 Q You mentioned the 25 cents per megawatt return. 5 How did you calculate that? 6 A I probably should not have -- that's just 7 talking to him about -- as I recall, some of the numbers he 8 described in terms of the costs associated with putting on 9 the trades and his expectation for the transmission loss 10 credit and his ability to predict the differences in the 11 LMPs between the various nodes. 12 BY MR. HOPKIN: 13 Q Did Dr. Chen ever discuss with you whether he 14 had found a specific way to eliminate or greatly reduce the 15 risk associated with these high-volume up-to congestion 16 transactions? By "risk," I mean the price risk as opposed 17 to the acceptance risk we discussed previously. 18 A The price risk of the day-ahead LMP? 19 Q Yes. 20 A I don't believe that he ever described it in a 21 way to eliminate this risk, and I'm not certain that he did 22 eliminate this risk. I believe that this was a risk that 23 was in our portfolio. 24 BY MR. TABACKMAN: 25 Q Did he ever describe to you -- did he ever 91 1 suggest to you that there was a way to structure a 2 transaction, an up-to congestion transaction in a way that 3 it could approach being risk-free because of the 4 transmission loss credit or words to that effect? I'm not 5 hung up on risk free, reduced risk, whatever. But the 6 transmission loss credit, he could structure a transaction 7 that because of the transmission loss credit it was very 8 highly likely that you would make money on that 9 transaction? 10 A He did say the transmission loss credit changed 11 the expected risk return. He never said he was able to 12 eliminate it. I paid him and hired him with the objective 13 to mitigate risk. That's what his job was, to help 14 mitigate risk in our portfolio. So we did discuss his 15 roles and his obligations to the fund. 16 Q Did he discuss with you more specifically the 17 ways in which he structured the actual trades he was 18 engaged in, between nodes, where sinking and sourcing was 19 going to occur? Did you have those kinds of discussions 20 with him? 21 A We had those discussions with him in general 22 terms. I don't recall discussing specific nodes, but we 23 had discussions in general terms. 24 Q And did he discuss with you -- do you recall 25 having discussions with him in which he talked about the 92 1 impact of the transmission loss credit on those -- on how 2 he selected where he was going to make his trades? 3 A Yes. 4 Q What do you recall him saying? 5 A That the inclusion of the transmission loss 6 credit encouraged him to do higher volume trades. 7 BY MR. HOPKIN: 8 Q Do you know what the relationship was between 9 the marginal loss surplus allocation and the high-volume -- 10 and the high volume trades? 11 A I'm sorry. One more time. 12 Q Sure. Did Dr. Chen describe to you or did you 13 talk about with him the relationship between the 14 high-volume nature of the trading strategy and its 15 relationship with the marginal loss surplus allocation? 16 A Yes. 17 Q Okay. And what did he say? 18 A That there was a new opportunity in the market, 19 and I believe it was my understanding he was continuing to 20 trade as he had done in the past, but he could introduce 21 another -- in addition to what he had previously done, 22 another trade that had a different risk associated with it 23 and that introducing this new trade that had a different 24 risk associated with it would be in our best interest. 25 Q Did he describe this new risk? 93 1 A Yes. 2 Q And what was it? 3 A Well, there were two risks, that both legs of 4 the trade would not be accepted into the market, and the 5 costs associated with the trade -- there were fixed costs 6 associated with the trade that we were guaranteed -- my 7 perception is that we were guaranteed to pay them with an 8 uncertain outcome. And the transmission loss credit was 9 unknowable, wasn't published, but days later, and was 10 variable, and sometimes didn't cover the fixed costs 11 associated with putting on the trades. 12 So that was a new risk that we were doing. We 13 were paying money, providing economic benefit to the 14 marketplace in a transparent and clearly documented manner 15 and didn't -- weren't guaranteed any sort of payout. 16 BY MR. TABACKMAN: 17 Q Let me ask you. If I understood what you said 18 before, though, the transmission loss credit made the 19 high-volume trades more attractive? 20 A Yes. 21 Q And why did the transmission loss credit make 22 high-volume trades more attractive? 23 A They made all trades more attractive. 24 Q I understand that, sir. But you're the one that 25 said they made the high-volume trades more attractive. How 94 1 did the transmission loss credit, at least your 2 understanding, make the high-volume trades more attractive? 3 A Because there was an additional payout that 4 previously was not given to participants. 5 Q And the higher the volume, the more that 6 potential payout would be? I'm just trying to make sure I 7 understand. 8 A Yes. But I would add also likely the increased 9 risk associated with it. 10 Q Because you were also increasing your fixed 11 cost? 12 A Yes. 13 Q But you had also said earlier that Dr. Chen told 14 you that this new factor, it looked like the -- again, I'm 15 trying to recall what you said. 16 A Uh-huh. 17 Q And I think I'm accurate that the likelihood of 18 the transmission loss credit could exceed -- there was a 19 likelihood it would exceed the fixed costs? 20 A Yes. 21 MR. O'DONNELL: Could I ask to go off the record 22 for a moment? 23 MR. HOPKIN: Yes. Let's go off the record. 24 (A discussion was held off the record.) 25 MR. BAPTIST: Go back on the record. 95 1 BY MR. BAPTIST: 2 Q Mr. Gates, I have one general follow-up question 3 for you. Since the investigation was initiated and you 4 became aware of FERC's investigation into these up-to 5 congestion transactions, have you had any follow-up 6 conversations with Dr. Chen? 7 A Yes. 8 Q In those conversations, have you ever asked him 9 to explain the trades at issue? 10 A Indirectly, yes. I didn't know the specific 11 trades at issue. I read the filings. What I was asking 12 him more was to explain the risks of the trades. The 13 documents claimed there was no risk. I didn't perceive it 14 as no risk, and I asked him to explain the risk and the 15 economic benefit that we provided to the market. 16 Q Was Dr. Chen's explanation of the risks any 17 different than your conversation from the June 25th 18 meeting? 19 A Yes. We certainly didn't discuss in June 20 receiving a letter from you guys two months later. So that 21 was a new risk of the trade. We discussed more the risks 22 associated with the legs -- both legs being put on. In 23 that e-mail, I believe he had said that we didn't realize 24 that risk during the summer -- that's how I interpreted it. 25 It wasn't clear to me, that. 96 1 Q In the summer, you weren't aware of the risks 2 associated with the two legs? Is that what you're saying? 3 I'm sorry. I'm trying to understand what you just said. 4 A In the June meeting, it's very possible that I 5 thought that the drawdowns that occurred in the account 6 were a result of both legs not being accepted. Whereas, in 7 the e-mail communications since this investigation began, I 8 now believe that that -- we may not have realized those 9 risks. That's to go back to an earlier statement where I 10 said that I was conflicted. I'm not sure what risks were 11 truly realized. The drawdowns and the losses in the 12 account, I'm not sure I can do an attribution analysis and 13 associate every dollar lost with one of these many risks 14 that were realized. 15 Q Just so I'm clear, what are the two legs that 16 we're talking about? 17 A I believe the transmission reservation through 18 OASIS -- and I'm not an expert, but this is what I 19 generally understand to be correct. The transmission 20 reservation through OASIS and the scheduling in the 21 day-ahead energy markets. 22 Q Were there any other legs associated with these 23 specific up-to congestion transactions that Dr. Chen 24 explained to you? 25 A I guess in its individual -- I believe that 97 1 he -- many of these trades occurred, and they were not -- 2 he placed many of these trades -- I believe all up-to 3 congestion trades have two legs, but he was placing many 4 up-to congestion trades. 5 So the trades that he was placing, he was 6 structuring in such a manner that he wasn't looking at each 7 one in a silo. He was constructing an overall portfolio of 8 exposure that he thought would be suitable. So two legs 9 over here may have been somewhat associated with two legs 10 over here in terms of the low correlation, in terms of 11 their ability to hedge risk. 12 Q Do you know what those legs were and how they 13 were associated with the two legs specific to the 14 high-volume up-to congestion transactions? 15 A Can you repeat that question? 16 Q Do you know how the two legs associated with the 17 high-volume up-to congestion transactions could have been 18 or were related to Dr. Chen's other legs in his model? 19 Do you want me to rephrase that? 20 MR. HOPKIN: Why don't we strike that. 21 BY MR. HOPKIN: 22 Q Am I correct that your understanding of how 23 up-to transactions works is each up-to transaction has two 24 legs in and of itself; correct? 25 A Correct. 98 1 Q One of those legs is the OASIS transmission 2 reservation; correct? 3 A Correct. 4 Q And the other leg is the up-to congestion 5 transaction itself; correct? 6 A I had referred to that as day-ahead energy 7 markets, but we can call it up-to congestion trade. 8 Q I want to use terms that you understand and 9 terms that you are comfortable with. 10 A I had referred to that as the day-ahead energy 11 market. 12 Q And it's your understanding, based on speaking 13 with Dr. Chen, that in addition to the two legs presented 14 by each individual transaction, multiple transactions that 15 he was engaged in may have themselves been part of a larger 16 trading strategy that itself had multiple legs; is that 17 correct? 18 A Okay. 19 Q Did Dr. Chen ever explain to you what the legs 20 in his larger -- in that second larger context you were 21 talking about of up-to congestion transactions? 22 A I believe that he said that he structured his 23 trades to diversify the portfolio and hedge risk. 24 Q Okay. Now, this may not have been clear, but 25 I'm directing my question with specific reference to the 99 1 high-volume up-to congestion transactions. So with that 2 clarification, did Dr. Chen ever discuss with you how -- if 3 they existed, and if they did, how they worked of whether 4 or not there were multiple legs involved with the 5 high-volume up-to congestion transactions? 6 A "Multiple legs" meaning more than two legs? 7 Q Two or more. 8 A Two or more? I was familiar with the two legs 9 strategy in the high-volume with the one up-to congestion 10 trade. As it relates to the high volume, I don't believe 11 that we specifically discussed coupling or combining other 12 trading strategies -- other up-to congestion trades 13 specific with his high-volume strategy. But my expectation 14 would be that, like the rest of the portfolio, that that 15 would have been done in a manner to hedge the portfolio or 16 to diversify the portfolio. 17 BY MR. BAPTIST: 18 Q You had stated that there were the two legs and 19 they might have related to other legs somewhere else in the 20 portfolio. Do you have any idea or understanding of how 21 they might have related? 22 A I have a guess now based upon reading some of 23 the public documents. 24 Q Did Dr. Chen ever explain the relationship or 25 potential relationships to you? 100 1 A The -- did he have -- I believe that he 2 explained to us that he was managing the portfolio in a 3 manner to diversify and hedge risk and that each trade was 4 looked in the aggregate level how it would complement the 5 overall positioning of the fund. 6 MR. BAPTIST: I think we will take a five- to 7 10-minute break right now. 8 (Recess.) 9 MR. BAPTIST: We will go back on the record. 10 BY MR. BAPTIST: 11 Q Mr. Gates, did Dr. Chen ever describe a type of 12 specific up-to congestion transaction whereby you place a 13 single up-to transaction between two nodes that are 14 electrically very close, for example south exp and south 15 imp? 16 A We didn't discuss those specific nodes. He 17 discussed his strategically taking bets and consciously 18 assessing the correlation or the relationship between the 19 nodes, the prices at the nodes. I know that sometimes he 20 strategically chose nodes that had a great degree of 21 separation, that he wanted to introduce that exposure into 22 the fund, and sometimes he strategically wanted nodes that 23 may have been more correlated or he thought may be more 24 correlated. 25 BY MR. HOPKIN: 101 1 Q I'm sorry. I didn't mean to interrupt you. 2 A Go ahead. 3 Q With specific reference to the transactions or 4 strategy Dr. Chen described for two nodes that were 5 correlated or highly correlated, did he do so with specific 6 reference to the high-volume up-to congestion transactions? 7 A To clarify the question, if it's all right, he 8 never guaranteed that any nodes would be highly correlated. 9 I don't believe he ever gave us assurance on any of these 10 trades that the high-volume trades that his prediction of 11 correlation would persist into the future. 12 So with that being said, yes, I believe I was 13 familiar with the fact that trades -- nodes that he thought 14 may be highly correlated were more suitable for the 15 high-volume trades. 16 Q Did he explain to you why that was? 17 A I believe that that was for introducing the 18 other risk into the fund, another component into the 19 overall management of the fund, that that was introducing 20 another bet, that the fixed costs associated -- we would be 21 compensated for taking the risk of paying all these fixed 22 costs into the system. 23 Q Compensated how? 24 A By net positive settlement all in, the 25 settlement of the LMPs in the day-ahead real-time on the 102 1 two nodes relative to the fixed cost, relative to the cost 2 associated with the transmission, relative -- including the 3 transmission loss credit. 4 Q And just so the record is clear, when you 5 say "transmission loss credit," do you also understand that 6 term to mean the marginal loss surplus allocation? 7 A Yes. 8 MR. HOPKIN: Thank you. 9 BY MR. BAPTIST: 10 Q You also used the term "highly correlated." 11 What do you mean when you say "highly correlated"? 12 A Two nodes that he expected would move in a -- 13 may move in a similar direction or a direction that he 14 predicted relative to each other so they could -- two nodes 15 that one node, if you knew the information on one node, you 16 could have a higher degree of certainty what the other node 17 would do. 18 Q Does that include nodes with similar pricing 19 points? 20 A I don't know what that means, a pricing point. 21 I don't understand the distinction between node and pricing 22 point. 23 Q When I say "pricing point," I mean the price at 24 the point. 25 A That's the correlation I'm speaking of. He's 103 1 correlating the pricing -- the LMPs or the prices at the 2 nodes relative to each other. So -- 3 Q But your definition of "highly correlated," does 4 that include nodes that have similar prices? 5 A When I say "highly correlated," he's expecting 6 that one node's direction will be predictive of the other 7 node's direction. Two data points can -- a data set can be 8 highly correlated, but they can't be the same price. They 9 can be inversely correlated. One goes up by a factor of 10 10. One goes up by a factor of 1. When I mean highly 11 correlated, I mean if you were to know one of the -- one 12 data point, one of the prices, you would have a high degree 13 of confidence of what the other price was. 14 So I believe he was looking at nodes that he 15 wasn't guaranteeing us would be highly correlated, but he 16 believed, based upon his research and knowledge and 17 modeling of the market, may be highly correlated. 18 MR. BAPTIST: Okay. Do you have any follow-up? 19 BY MR. HOPKIN: 20 Q One follow-up question. In addition to being 21 highly correlated, would the prices also be nearly the 22 same, if not identical? 23 A My best guess is the trades that he was doing, 24 that was the hopes that they would be similar or the same, 25 but I'm not even -- I suspect he may have some trades that 104 1 he said this one goes up by X, the other node will go up by 2 a factor of 2 X. So he could have adjusted the trade. But 3 I believe a lot of his trades had that risk embedded in 4 them that the two prices would be the same. 5 Historically, he may have thought they were 6 similar, but I don't believe he had any assurance and he 7 certainly gave us no assurance that that relationship would 8 persist. And again, that's another -- in my mind, another 9 risk introduced into the fund, an uncertainty. There was 10 no guarantee -- I was never given any guarantees that nodes 11 that historically had had similar prices would be priced 12 the same tomorrow. 13 MR. HOPKIN: Okay. 14 BY MR. BAPTIST: 15 Q Did Dr. Chen ever describe sets of two 16 transactions where the source and sink path of one 17 transaction, for example, MISO and PJM, offsets completely 18 the source and sink path of the second transaction? 19 A When you say "offsets completely," what do you 20 mean with that term? 21 BY MR. HOPKIN: 22 Q To elaborate, where you would have the same 23 exact path, and you would have one transaction running one 24 way on that path and the second transaction running the 25 other way on that path in equal volumes. 105 1 A I don't recall ever specifically talking about 2 this particular trade. It doesn't surprise me. My 3 expectation of him was to look at the portfolio in 4 aggregate and manage risk of the overall fund in the 5 aggregate. So I very much would have hoped that he would 6 have managed the portfolio on a macro level, and given what 7 I know about the high-volume trades, this seems like a 8 natural thing that may be suited for that type of strategy, 9 again I believe still with significant risk. 10 Q Is there anything else that comes to mind that 11 you would like to share with us about what Dr. Chen may 12 have described to you or talked about with you with regard 13 to the high-volume up-to congestion transaction strategy? 14 A Nothing immediately comes to mind. 15 I think we're going to have a break, and if 16 Earle and I have a chance to speak, maybe we could circle 17 back to that question at that point, if that's all right? 18 MR. BAPTIST: I have one housekeeping matter I 19 want to go over. I believe counsel identified that you 20 represent another person or entity in this investigation, 21 but you didn't actually specify which one, and just so the 22 record is clear, who are the other witnesses, people or 23 entities that you represent in this investigation? 24 MR. O'DONNELL: The only other witness is Larry 25 Eiben, but we do represent Powhatan. We represent TFS 106 1 Capital, LSE, which is shown on this sheet, LSE Capital 2 Management. 3 MR. HOPKIN: Counsel, are you referring to 4 Exhibit 2? 5 MR. O'DONNELL: I am. 6 Thank you. I should remember my own role, which 7 is to tell witnesses that, that sort of thing. 8 Those are the entities that we represent. 9 MR. BAPTIST: Would you like to take five 10 minutes to confer with your client? 11 MR. O'DONNELL: That's fine. 12 MR. BAPTIST: We can go off the record. 13 (A discussion was held off the record.) 14 (Recess.) 15 MR. BAPTIST: We will go back on the record. 16 Counsel, I believe you have a couple of 17 questions you wanted to ask your client? 18 MR. O'DONNELL: Yes. Thank you. 19 EXAMINATION 20 BY MR. O'DONNELL: 21 Q Mr. Gates, do you recall being asked at one 22 point who you conferred with in preparation for this 23 deposition other than White & Case and counsel? 24 A Yes. 25 Q During the break, did you have a chance to 107 1 refresh your recollection on whether there was anyone else 2 that you spoke to that you hadn't mentioned? 3 A Yes. 4 Q Who was that person? 5 A Richard Tabors from CRA. 6 Q And what was the reason that you conferred with 7 Dr. Tabors? 8 A It's my understanding that he's an expert in the 9 space, that he could talk to us and help us understand the 10 nuances of the market and could help prepare us for these 11 discussions. 12 Q Okay. The second item. You mentioned at one 13 point a variety of transactions that entities that are 14 mentioned on Exhibit 2 engaged in the energy space. I'm 15 going to ask you a question that relates to the timing of 16 those transactions. 17 During the period of May 2010 through August of 18 2010, did any of the entities that are listed and shown on 19 Exhibit 2 engage in transactions in PJM, NYISO, ISO New 20 England? And I'm including in "transactions" incs, decs, 21 FTRs, energy, capacity, any type of transactions other than 22 the up-to transactions that are being performed on behalf 23 of Powhatan by HEEP. 24 A Can you remind me, what are the time frames 25 you're asking about again? 108 1 Q May of 2010 through August. During this period 2 of time, were there any other types of transactions that 3 any of the entities that are mentioned on Exhibit 2 engaged 4 in other than, of course, the up-to transactions which have 5 been the subject of this deposition? 6 A Yes. 7 Q Which? 8 A Hunterized Energy Fund had exposure to the up-to 9 congestion trading in the first week or so of May. 10 Q Beginning at the end of May when Powhatan was 11 engaged in the transactions that are the subject of this, 12 were there any other trades in PJM or any of the other 13 markets beginning at the end of May and ending in August? 14 A No. 15 MR. O'DONNELL: That's all I have. 16 MR. BAPTIST: I have no follow-up questions. 17 EXAMINATION 18 BY MR. HOPKIN: 19 Q Briefly. Who is Dr. Tabors? 20 A He works for CRA. I believe he's an expert in 21 the power markets. I believe he was a professor at MIT for 22 a while and was involved in helping design the market 23 structure years, if not decades, ago. 24 Q And CRA is a consulting firm of some kind? 25 A Yes. 109 1 Q Did he specifically cover up-to transactions 2 with you? 3 A We were specifically discussing the up-to 4 congestion trades, yes. 5 MR. HOPKIN: Okay. Thank you. 6 BY MR. BAPTIST: 7 Q Has Powhatan obtained Dr. Tabors as an expert in 8 this litigation? 9 A Yes. I don't know if this matters. 10 Technically, he was retained by White & Case, but with our 11 authorization. 12 MR. BAPTIST: Okay. That's all I have. 13 BY MR. TABACKMAN: 14 Q Did you discuss with Dr. Tabors the kinds of 15 transactions Mr. Baptist asked you about just before the 16 break, the ones where there were price correlations or 17 close prices? 18 A Yes. 19 MR. BAPTIST: Okay. I think we're done. Let's 20 go off the record. 21 (A discussion was held off the record.) 22 (Whereupon, at 1:13 p.m., the deposition was 23 concluded.) 24 25 110 1 C O N T E N T S 2 3 WITNESS EXAMINATION 4 KEVIN J. GATES 5 by FERC Counsel 4, 108 6 by Mr. O'Donnell 106 7 8 9 10 11 E X H I B I T S 12 EXHIBIT NUMBER IDENTIFIED 13 Exhibit Gates 1 5 14 Exhibit Gates 2 45 15 16 17 18 19 20 21 22 23 24 25