1 1 BEFORE THE UNITED STATES 2 FEDERAL ENERGY REGULATORY COMMISSION 3 4 - - - - - - - - - - - - - - -x 5 In the Matter of: THE : 6 INVESTIGATION OF : IN10-5-000 7 PJM UP-TOS CONGESTION : 8 TRANSACTIONS : 9 - - - - - - - - - - - - - - -x 10 11 12 DEPOSITION OF CHAO CHEN 13 REDACTED 15 16 17 18 19 Philadelphia, Pennsylvania 20 Tuesday, May 8, 2012 21 22 23 REPORTED BY: 24 DONALD R. THACKER 25 2 1 Deposition of CHAO CHEN called for examination pursuant 2 to notice of deposition, on Tuesday, May 8, 2012, in 3 Philadelphia, Pennsylvania at the, Offices of Drinker, 4 Biddle & Reath, One Logan Square, Suite 2000 at 1:50 p.m., 5 before DONALD R. THACKER, a Notary Public within and for 6 the Commonwealth of Virginia, when were present on behalf 7 of the respective parties: 8 9 STEVEN TABACKMAN, ESQ. 10 JAMES C. OWENS, ESQ. 11 Attorney Advisors 12 Division of Investigation 13 Federal Energy Regulatory Commission 14 Office of Enforcement 15 888 First Street, Northeast 16 Washington, DC 20426 17 On behalf of FERC 18 19 WILLIAM M. McSWAIN, ESQ. 20 Drinker, Biddle & Reath, LLP 21 One Logan Square, Suite 2000 22 Philadelphia, Pennsylvania 19103-6996 23 215.988.2775 24 William.McSwain@dbr.com 25 On behalf of Powhatan and the witness 3 1 P R O C E E D I N G S 2 Whereupon, 3 CHAO CHEN 4 was called as a witness and, having first been duly sworn, 5 was examined and testified as follows: 6 EXAMINATION 7 BY MR. OWENS: 8 Q Mr. Chen, as you know my name is James Owen, and 9 I am an attorney in the Office of Enforcement of the 10 Federal Energy Regulatory Commission. With me today is 11 Steve Tabackman, another attorney with the Office of 12 Enforcement. Are you represented by counsel today? 13 A Yes. 14 Q Will counsel please introduce himself? 15 MR. McSWAIN: Bill McSwain representing the 16 witness and Powhatan, and I work at Drinker Biddle. 17 BY MR. OWENS: 18 Q Mr. Chen, are you aware that Mr. McSwain 19 represents the company as well as you? 20 A Yes. 21 Q Does he represent you in your personal capacity 22 or does he represent the company solely? 23 MR. McSWAIN: I represent the company, which I 24 understand is the subject of the investigation, but any 25 witness for Powhatan who has appeared, I am defending their 4 1 deposition. 2 BY MR. OWENS: 3 Q Are you comfortable with this type of 4 representation? 5 A Yes. 6 Q I will be taking your deposition today in 7 connection with a formal nonpublic investigation being 8 pursued, or being conducted pursuant to FERC's regulations 9 to ascertain whether certain entities violated federal 10 energy laws, regulations or orders; do you understand? 11 A Yes. 12 Q I would advise you that whoever knowingly or 13 willfully states or subscribes under oath to any material 14 matter that he or she does not believe to be true to an 15 Officer of the United States is guilty of perjury and may 16 be fined, imprisoned or both. For the purpose of this 17 deposition Mr. Tabackman and I are officers of the 18 United States; do you understand? 19 A Yes. 20 Q Let's start with some general ground rules so we 21 understand what we are going to be doing moving forward. 22 First of all, have you ever been deposed before? 23 A No. 24 Q Before we begin I would like to give you some 25 instructions. Your counsel may have already talked to you 5 1 about these but I want to be sure that you understand them. 2 This deposition is an on the record proceeding, the court 3 reporter will transcribe everything that is being said on 4 the record. For that reason it is important that you 5 provide oral answers to questions, nods, or shakes or other 6 nonverbal gestures will not be understood or recorded; do 7 you understand? 8 A Yes. 9 Q To help the court reporter, please don't start 10 your answers until I have fully completed my questions, and 11 by contrast I will try to not interrupt you while you are 12 answering a question; do you understand? 13 A Yes. 14 Q If you do not understand a question please let 15 me know and I will try to rephrase it to help you better 16 understand. When you answer a question the record will 17 reflect that you understood the question. 18 A Yes. 19 Q I am conducting this deposition and will be the 20 primary person asking you questions. Mr. Tabackman might 21 also ask you questions at some points, but we will make 22 sure we do this in a manner that is not confusing to you. 23 You are directed to answer each question fully 24 and truthfully. If your counsel objects to the question 25 the objection will be noted for the record, but you will 6 1 still be expected to answer the question; do you 2 understand? 3 A Yes. 4 Q However, you may refuse to answer any question 5 that may incriminate you or may subject you to a fine, 6 penalty or forfeiture. This is a right you have under 7 the Fifth Amendment to the United States Constitution. If 8 you refuse to answer a question you must fully explain the 9 reasons for your refusal. If you assert a privilege not to 10 answer such as self incrimination, you must assert the 11 privilege personally; okay? 12 A Okay. 13 Q And if at any time during the deposition you 14 wish to go off the record, please ask me and I will make 15 arrangements to do so; do you understand? 16 A What does that mean to go off the record? 17 Q To go off the record means that the court 18 reporter will cease transcribing this deposition for the 19 purpose of a conversation that won't be quoted in future 20 matters. 21 A Okay. 22 Q After you have finished answering a question and 23 before I ask the next question, if you need a break for any 24 reason, please let me know and we can take a break. 25 A Okay. 7 1 Q I will be handing you a few exhibits throughout 2 the deposition today. Please don't mark on them because we 3 will collect them at the end of the deposition, unless you 4 would like us to see your notes or other scribbles? 5 A I agree. 6 Q And at the conclusion of your testimony you will 7 be given an opportunity to make any further statements that 8 you wish to give concerning the subject matter of this 9 deposition. Do you have any questions about any of these 10 procedures? 11 A Only about the objections, so if you object to 12 something I still have to answer the question, if Bill 13 objects -- 14 MR. McSWAIN: He is saying that any objection 15 that I make I am preserving the record and you go ahead and 16 answer the question unless I instruct you not to answer 17 something based on privilege, then you wouldn't answer. 18 THE WITNESS: Okay. 19 BY MR. OWENS: 20 Q You have a variety of privileges under the 21 Constitution as well as an attorney-client privilege. 22 MR. McSWAIN: I will make it clear. 23 THE WITNESS: Yes. 24 BY MR. OWENS: 25 Q Are you taking any medication or suffering from 8 1 any physical or mental illness or condition that would 2 prevent you from testifying today? 3 A No. 4 Q Are you appearing voluntarily for this 5 deposition? 6 A Yes, although I think I have to be here. 7 MR. McSWAIN: He means there is no subpoena or 8 anything like that forcing you to show up. 9 THE WITNESS: Okay. I actually I thought I 10 needed to be, but anyway. 11 MR. McSWAIN: We agreed among attorneys that 12 witnesses would show up without them having to issue 13 subpoenas. I think that is what you are getting at; right? 14 MR. OWENS: Yes. 15 THE WITNESS: Yes, it is voluntary. 16 MR. McSWAIN: Probably doesn't feel voluntary. 17 BY MR. OWENS: 18 Q Let's start with some basic questions. In 19 preparing for the deposition today, did you review any 20 documents or speak to anyone other than your attorney about 21 the nature of the investigation or the nature of your 22 possible testimony? 23 A I didn't speak to anyone about my testimony. I 24 talked to Kevin Gates and Rich Gates about the fact that 25 the FERC is investigating us, and about the legal strategy 9 1 in general. 2 Q Did you review any document or discuss any 3 documents with Rich or Kevin Gates? 4 A No, I did not. 5 Q And you are aware that the Commission has issued 6 a variety of what we call data requests -- 7 A Yes. 8 Q -- to your company? In responding to those data 9 requests do you recall searching your files for what are 10 called responsive documents? 11 A Yes. 12 Q And to your knowledge you produced those? 13 A Yes. 14 Q When was the last time you spoke with Kevin or 15 Richard regarding the deposition and the investigation? 16 A I spoke to Rich earlier today, I just saw him 17 for lunch, and I talked to Kevin yesterday. 18 Q Let's begin with some background. Where did you 19 go to college? 20 A I went to college at University of Virginia in 21 Charlottesville, and after that I went to University of 22 California at Berkeley. 23 Q What did you major in at UVA? 24 A Electrical engineering and same at Berkeley. 25 Q Did you get good grades? 10 1 A I believe my grade point average was 3.7 even. 2 Q At -- 3 A At UVA. At Berkeley I don't know, I don't know 4 if we had -- 5 Q I understand you have a Ph.D. from Berkeley? 6 A Yes. 7 Q Is that in chemical engineering? 8 A Electrical. 9 Q Electrical engineering, excuse me. What was 10 your first job after college, after your Ph.D., I should 11 say? 12 A I worked for the University. 13 Q Of California? 14 A Yes, I did the same research I was doing then, I 15 was a grad student working on transportation, working for 16 Department of Transportation in California. 17 After I graduated I worked at the same project 18 but as a staff rather than a grad student. 19 Q What year did you graduate with your Ph.D.? 20 A 2002. 21 Q How long did you work on this continuing project 22 with the Department of Transportation? 23 A Since 2002 or -- 24 Q After graduation. 25 A After I graduated -- 11 1 Q How long did you continue with you this job? 2 A Two years. 3 Q So in 2004 you changed jobs? 4 A Yes. 5 Q What did you do then? 6 A I started with TFS Capital in 2005, February of 7 2005. 8 Q And was this your first job with an investment 9 company, a financial investment company? 10 A Yes. 11 Q What background do you have in financial 12 services? 13 A I did not before TFS. I came because Rich and 14 Kevin wanted me to do the technology infrastructure for the 15 company, and that is what I was doing for CalTrans, before 16 leaving. 17 Q So you knew Kevin and Richard prior to joining 18 TFS? 19 A Yes. 20 Q How so? 21 A I was Richard's roommate first year at UVA, and 22 so Kevin was also in our building. 23 Q So you all went to college together and 24 graduated together? 25 A Yes. 12 1 Q And you kept, obviously you kept in touch 2 through the years? 3 A Yes. 4 Q So you joined TFS to work on some IT projects? 5 A Yes. I also joined for the data analysis part, 6 so my job is kind of split into two parts, the bigger part 7 is technology, but I also do analysis on the strategies 8 that we develop. 9 Q Let's unpack that a little bit, if you don't 10 mind. First of all, when you say technology, when I think 11 of someone working in IT I think of somebody who is fixing 12 a computer. Is that what you are referring to or 13 something -- 14 A Not exactly, sorry, not exactly. When I was at 15 Berkeley I worked on a data base of traffic data. So it is 16 basically a data mining project, data warehousing, right, 17 where you collect data, you store them in a database and 18 you do stuff, do analysis on them. 19 So at TFS or at finance firms in general, people 20 do similar things except their data are not traffic data, 21 but they are finance data. So when I came I put in, for 22 example, I put in, I replaced the existing processes with, 23 you know, what I thought was a better way to do things, 24 which is putting in a database, writing automated 25 algorithms to crunch data, whereas, before I came we were 13 1 using Excel spreadsheets, very manual, error prone, so that 2 is the kind of thing that I am talking about when I say 3 technology, which is more like automation, information 4 technology, you know, sifting through data and finding 5 patterns. 6 Q Does that tie in to your analysis at TFS? 7 A Yes. So they are very closely related, so when 8 we say analysis at TFS, an example of that is we will 9 purchase a quite a data base of historical data, say for 10 the last 10 years, and we will run different strategies or 11 simulate different strategies on them, and find one that 12 would have worked in history. 13 So, that is usually some formula, that you buy a 14 stock when it goes up and you sell it when it goes down, 15 and that logic is then transferred into a computer program. 16 So a person doesn't sit there and watch them, but you make 17 a computer, you know, collect the data and make the 18 decisions on where to buy and where to sell. So that 19 second part is technology but the first part is analysis. 20 It is a progression from analysis to technology. 21 Q Would you characterize TFS as a trading, as a 22 quantitatively heavy model? 23 A Yes. 24 Q And has that type of model, that type trading 25 strategy, has that applied across the board at the various 14 1 funds that TFS has either launched or invested in over the 2 years, to your knowledge? 3 A So can you clarify which funds? I just want to 4 make sure you are talking about the funds that we have. 5 Well, which fund were you talking about? 6 Q Sure, let's start with the, my understanding is 7 you have some, TFS has some mutual funds, has some 8 proprietary funds? 9 A Yes. 10 Q So with the mutual funds, is that a quantitative 11 analysis that is applied to determine the trading 12 strategies? 13 A Yes, we have three mutual funds, and they are 14 all quantitative. 15 Q So you are crunching very large amounts of data 16 in order obtain what you predict to be the best results? 17 A Yes. 18 Q Does that type of model also apply to the 19 proprietary funds? 20 A Can you give an example? I just want to be more 21 specific, what do you mean by proprietary funds? 22 Q Sure. I understand that there are a variety of 23 funds that are not open to the general public but are open 24 to partners or family members of partners at TFS such as 25 Huntrise Fund of Funds; is that a fund that you have heard 15 1 of? 2 A Yes, thank you, I appreciate that, because we 3 have hedge funds that are -- we have hedge funds that are 4 open to the public, so I just wanted to know what you are 5 talking about. 6 The proprietary funds, let me think what they 7 are. Powhatan, of course is one. Basically there are 8 different models. So Huntrise Fund of Funds, like the name 9 suggests is, it invests in other products. Sometimes it 10 invests with other partners who trade with whatever 11 strategy that they use, and we don't know what they are. 12 So in general Huntrise Fund of Funds is not 13 managed quantitatively. For example, we bought a house one 14 time, and put it in the fund but, you know, I can't -- I 15 can't say that they are never not quantitative, but mostly 16 it is not quantitative, often it is with outside partners 17 that we don't know what they are doing. 18 Q Do you, to your knowledge do you, by you I mean 19 TFS, apply quantitative methods to attempt to understand 20 what these partners might be doing to assess the relative 21 risks and rewards of particular investments? 22 A We don't usually do that. For example, we 23 invest with a fund called Cross Court, and I believe it is 24 just some guy trading, and which don't get to see the 25 trades. So we see nothing from, you know, most managers. 16 1 They don't tell us what they are doing. Every month you 2 see a profit and loss, and we don't even look at that. 3 Some -- I myself don't even see the monthly profit and 4 loss. If I want to know how much we lost I have to ask 5 somebody. 6 Q Are you currently an employee or partner at TFS? 7 A I am a partner. 8 Q When did you become a partner? 9 A Two years, I think two years after I joined, 10 maybe 2007, somewhere around there. 11 Q And as a partner do you have some managerial say 12 over these proprietary investments? 13 A Yes, we work by committee. We vote. 14 Q And with these funds that you say that you 15 invest with these managers and you don't know what they are 16 trading, how do you ensure that you haven't just invested 17 with Bernie Madoff? 18 A We try to do our due diligence the best way we 19 can. Usually people don't tell you exactly what they are 20 doing. We look at their track record, you know, I would 21 say we look at it probably too much. And another thing is 22 we ask them, do you have your own money invested in the 23 fund? But it is very hard. I don't know that they are not 24 Bernie Madoff and you take a chance, yes. 25 Q When you get involved in a new sector do you 17 1 undertake any due diligence to ascertain or educate 2 yourself -- 3 A Yes. 4 Q -- as to what is going on in that sector? 5 A Yes, we try, yes. 6 Q What sorts of things would you do when you 7 entered a new sector, something that you are unfamiliar 8 with? 9 A Well, for example, if we want to invest in a 10 fund that buys mortgages, I would read some papers on the 11 mortgage market or read whatever material I can, you know, 12 to understand who the players are, and what are the 13 opportunities or inefficiencies that people have found, you 14 know? Does it make sense, why is there an opportunity, you 15 know, why is this person able to make money I am about to 16 invest with, someone, why I do think he is going to make 17 money more than the other people that he would compete 18 with. 19 Q So you educate yourself as to the, at least 20 parameters of the sector, even if you don't know the 21 specifics of a particular trading strategy? 22 A Yes, and we would ask them, you know, anyone we 23 are investing with we would ask them, how do you invest, 24 you know. We don't really ask specifics because people 25 don't tell you, they can't tell you here is my formula, 18 1 that is what I do, and have you go over it and see if it 2 made sense to you, but you just kind of get an idea of 3 their thought process. 4 One big thing is we try to determine if they are 5 just lucky or if they actually have something that might 6 persist into the future. So if someone took a big bet on 7 the S&P 500, they shorted it in 2008, you know, and made 8 100 percent, this guy John Paulson, he shorted mortgages, 9 he made a lot of money, and he was a hero, and a lot of 10 people wanted to invest with him, and then a year later he 11 lost a lot of money, you know. 12 So, again, you never know whether it is luck or 13 not, but you try to get an idea of their thought process, 14 so maybe it is not luck, that they know something. Or, you 15 know, just in general, how smart do they seem when you talk 16 to them, when they communicate with you, you know, that 17 kind of thing. 18 Q In your role at TFS, since you joined the firm, 19 do you personally participate in this due diligence or is 20 this something that somebody else typically does? 21 A My involvement is typically -- I am not the one 22 doing the due diligence. I hear, so usually it is Kevin 23 Gates that does the due diligence, and he would report to 24 us, or I mean Kevin or Larry or Rich will report to us what 25 they know, and we would, there is five of us, we get 19 1 together and make these decisions, and we would try to 2 figure out next steps or, you know, agree or not agree to 3 invest. 4 Q Do different partners at TFS tend to focus on 5 different sectors or different areas of interest? 6 A Yes. 7 Q And what did Kevin Gates, what does he tend to 8 focus on? 9 A He focuses on power. He is, I would say he is 10 more involved with the outside investments. Like for me, I 11 am more operational, you know, my day-to-day job is TFS, 12 managing TFS, the mutual funds, the hedge funds that we 13 manage ourselves, whereas, I would say Kevin and Rich would 14 do more business development. 15 Q Would you find yourself called in to assist 16 Kevin in understanding a new market or a new investment? 17 A Yes. 18 Q Is that something that commonly happens? 19 A I mean there is not that many different 20 investments that we have made, but common? I mean it 21 happened with electricity, he pulled me in to talk about 22 electricity. I don't think we talked about anything else. 23 Q That is a good segue. When did the partners at 24 TFS first became interested in the power markets? 25 A We were contacted by Steve Giblin who traded for 20 1 Dominion. Am I giving too much information or -- 2 MR. McSWAIN: I think that is fine. 3 THE WITNESS: Yes, I don't know what is 4 proprietary and what is not, but I don't know what year it 5 was, you probably have that e-mail. 6 MR. McSWAIN: I think they just want to know 7 generally how you guys got into power trading. If there 8 are particular names, you don't have to name names. It is 9 fine, you can do that as well. I wouldn't talk about some 10 proprietary strategy of somebody else that trades with you, 11 though. 12 BY MR. OWENS: 13 Q Yes, we are not necessarily interested in 14 somebody's proprietary process? 15 A I am just not used to the process so I don't 16 know what is appropriate at a deposition and what is not. 17 We were approached by a trader who told us that 18 he wants to trade power and he can make money trading 19 power, and he would like to work for us trading electric 20 power. 21 I don't remember exactly what year it was, but 22 you know, it is not long after came to TFS, maybe one or 23 two years after I came to TFS. 24 Q And when did you first hear about Dr. Alan Chen? 25 A It was a few years ago, I would say three years 21 1 ago, but I am not sure. But -- yeah, there are e-mails. 2 Q How do you recall learning about Dr. Chen? 3 A Kevin found him. I believe he just called a lot 4 of traders at PJM. 5 Q What if anything did you know about -- strike 6 that. 7 What -- are you familiar with the type of 8 trading that Alan Chen engages in, that is to say, the type 9 of product that he trades? 10 A I know that he trades the UTC market in PJM. 11 Q By UTC you mean Up To Congestion? 12 A Up To Congestion. 13 MR. McSWAIN: Are you asking Chao what he knew 14 at the time when he first met Alan Chen, or what does he 15 know now? 16 BY MR. OWENS: 17 Q Well, let's start with what you know now. 18 A That is what I know now. 19 Q What did you know in 2008 about the UTC market? 20 A We did not know about UTC before we met Alan, 21 and I don't know when we knew about it, when he told us 22 about UTC. Before we met him our idea of PJM is INC/DEC 23 from the day ahead real-time market. So this how I 24 remember it, and sometime after we met Alan we became aware 25 of Up To Congestion. 22 1 Q Do you recall Alan educating you as to what Up 2 To Congestion trading was all about? 3 A We did ask him, and he did, yes, he told us, he 4 told he told us things about UTC, how it works, yes. 5 Q To your understanding today, what is involved in 6 a UTC transaction? 7 A My understanding is that you are betting on 8 congestion in real-time versus congestion in the day ahead 9 market. So I think of it as you have a transmission line 10 and tomorrow the congestion could be $10 to $20, and today 11 you can put on a trade, for example, you can say I will buy 12 congestion for $20. So tomorrow becomes $21, you make $1, 13 and UTC becomes $19, you lose a dollar. That is my 14 understanding of the basic idea of UTC. 15 Q When did you develop this level of knowledge of 16 the UTC trades? 17 A Well, I can't remember exactly when I came to 18 that understanding, but it is -- could probably 2010. 19 Q Let's mark Exhibit 203, please. 20 (Chao Chen Exhibit 203 identified.) 21 BY MR. OWENS: 22 Q I have just handed over Exhibit 203 which is an 23 e-mail from Kevin Gates to Krishna Sinha with a -- 24 MR. McSWAIN: Can I just ask a quick question, 25 why is it called 203? 23 1 MR. OWENS: As I mentioned earlier, I had 2 pre-marked these. 3 MR. McSWAIN: Okay, so -- 4 MR. OWENS: Technically it is number three for 5 this record. 6 (Discussion off the record.) 7 BY MR. OWENS: 8 Q I would also like to hand over Exhibit 202. 9 (Chao Chen Exhibit 202 identified.) 10 BY MR. OWENS: 11 Q 202 you will see is an e-mail from Kevin Gates 12 to Krishna Sinha with a copy to Chao Chen. 202 is Bates 13 marked POW9725, and it is dated May 28, 2008. 203 is Bates 14 marked POW9774, and it was sent on June 7th, 2008. 15 Mr. Chen, I think you will notice that each of 16 these documents to the exhibit contains some information 17 that either indirectly purports or directly purports to be 18 relayed by Alan Chen; is that correct? 19 MR. McSWAIN: Do you mind to give him a minute 20 to read 202 especially. 203 is short. 21 MR. OWENS: Oh, sure. 22 MR. McSWAIN: Why don't you take your time and 23 read both of them. 24 THE WITNESS: Okay. Would you repeat the 25 question? 24 1 BY MR. OWENS: 2 Q I hadn't put one on the table, I believe. 3 A Oh. 4 Q Looking at these couple of e-mails, does this 5 refresh your recollection that timing wise you probably 6 learned about UTC trades sometime in the late spring or 7 early summer of 2008? 8 A I don't remember these e-mails but I agree with 9 you that these are from 2008, and I have no reason to doubt 10 that. 11 Q Okay. And so at this point in time, that is to 12 say, May and June of 2008, is it your understanding that 13 Powhatan, that is to say, well, Huntrise I believe at this 14 point, was already engaged with Alan Chen to engage in the 15 UTC trades? 16 A I am sorry, can you repeat the question? 17 Q Looking at these documents is it your 18 understanding that by this point in time, that is to say 19 May-June of 2008, TFS through one of its funds, through 20 partner's funds, had already begun working with Alan Chen 21 on the UTC trades? 22 MR. McSWAIN: You said TFS -- 23 BY MR. OWENS: 24 Q Let's, Huntrise Energy Fund I believe is the 25 actual fund that -- 25 1 MR. McSWAIN: Okay. 2 BY MR. OWENS: 3 Q -- had contractual relationship with Alan Chen 4 at this point? 5 A That is consistent with this document, yes. 6 MR. McSWAIN: Which document are you looking at? 7 THE WITNESS: 202, the PnL. 8 BY MR. OWENS: 9 Q I would like to hand the witness Exhibit 204. 10 (Chao Chen Exhibit 204 identified.) 11 BY MR. OWENS: 12 Q Take your time looking at this. 204, for the 13 record, is Bates marked POW8996, an e-mail sent by Kevin 14 Gates to Chao Chen, July 22, 2008. Let me know when you 15 have had a chance to glance at it. 16 A Okay. 17 Q If you will look at the top e-mail, that is to 18 say the last in sequence, Kevin's e-mail to you where he is 19 forwarding the exchange that he has had with Alan Chen, he 20 says, I asked Alan more about his trading and I guess that 21 it is good that it doesn't seem that he is writing 22 insurance against congestion. Makes we want to give him 23 more money. 24 What does insurance against congestion, what 25 does that mean? 26 1 A That is another thing that we think about when 2 we think about investment strategy -- 3 MR. McSWAIN: If I could just interject, on the 4 question, are you asking him in general what that phrase 5 writing insurance means, or are you asking him what Kevin 6 Gates thought it meant? 7 BY MR. OWENS: 8 Q I am asking him what he thought it meant, what 9 Mr. Chen thought it meant. 10 MR. McSWAIN: Okay. 11 THE WITNESS: So to me, insurance means if I 12 sell you an option on IBM. The option allows to you buy 13 IBM at $100 up to, you know, next Friday. So that is a 14 form of insurance, because your profit and loss is, your 15 loss is capped, that you are insuring against losses, 16 versus you could have bought IBM yourself, then you would 17 be taking a risk that IBM would go down to zero. 18 So by buying a call option on it, you are 19 basically saying I want to take the up side but I don't 20 want the down side. And you pay me, so I will say, if IBM 21 goes down I will take the down side; so that is insurance. 22 So you can make money that way because options you have to 23 pay me nor that option. 24 BY MR. OWENS: 25 Q Pay me, meaning pay a premium for the option? 27 1 A Pay, yes, pay period for the option, you give me 2 a dollar, I guarantee you the risk-reward. 3 And so you know you can always sell insurance, 4 you can always, you think you are making money by selling 5 insurance, but you are taking a risk, that is what it is. 6 So it is not for free. 7 Q So this was, am I correct in believing that this 8 is part of the process of you and Kevin educating 9 yourselves about the, what kind of trades, the kind of 10 products that Alan Chen traded? 11 A Yes. 12 Q I will hand the witness Exhibit 208. 13 (Chao Chen Exhibit 208 identified.) 14 BY MR. OWENS: 15 Q While you are looking at that, 208 is Bates 16 marked POW17336, it is an e-mail from Kevin Gates to Chao 17 Chen and Alan Chen on October 6, 2008; is that correct? 18 A October 6, 2008, yes. 19 Q Do you recall -- I am sorry, let me know when 20 you are ready, Chao. 21 A I am ready. 22 Q Do you recall having a meeting with Alan Chen in 23 2008? 24 A Yes. 25 Q Does this reflect the timing of it? 28 1 A Yes. 2 Q Did you meet at Hunan at 6:30 that night? 3 A We had dinner there, I think we picked him up at 4 the airport. I don't remember if I picked him up, but we 5 had dinner at a Chinese restaurant that evening. 6 Q What did you discuss? 7 A I don't remember exactly what we discussed. It 8 was a long time ago. 9 Q Do you know why you called a meeting with him? 10 A Yes, we wanted to talk to him about his trading, 11 and we wanted to understand more about his trading. 12 Q At that point you had been trading with him for 13 at least a few months; is that correct? 14 A According to these e-mails, yeah. I don't 15 remember it that far back, but yes. 16 Q So this was an opportunity to educate yourselves 17 further about the UTC trades and the kinds of transactions 18 that you guys were investing in through Alan Chen? 19 A Yes, it was an opportunity to talk to him about, 20 to try to understand about his trading. 21 Q At some point subsequent to that meeting, a few 22 months later, do you recall Kevin seeking to expand the 23 relationship with Alan Chen? 24 A Yes, I don't know when we sought to expand but 25 after the meeting we decided to put more money with him. 29 1 Q Were there -- do you recall any impediments to 2 expanding the relationship? 3 A I don't remember. 4 Q I will pose to the witness Exhibit 210. 5 (Chao Chen Exhibit 210 identified.) 6 BY MR. OWENS: 7 Q While the witness reviews the document or reads 8 the record, Exhibit 210 is Bates-stamped POW17242, it is an 9 e-mail from Kevin Gates to Alan Chen, dated June 9th, 2009. 10 A Okay. 11 Q If you will look to the bottom e-mail on the 12 first page, appears to be from Alan Chen to Kevin on 13 June 9th? 14 A Yes. 15 Q The third sentence reads, I hope you can 16 understand that it is kind of difficult for me to disclose 17 the details of my trading strategies, even with those 18 agreements we talked about. I'd probably only disclose 19 general trading strategies to the investors as I did to you 20 guys. 21 Does that correctly reflect your memory of your 22 relationship with Alan to that point? 23 A Yes, it does. 24 Q So he wasn't sharing his secrets with you, he 25 was just speaking more generally about the UTC trades? 30 1 A That is right. 2 Q Looking to the last e-mail in sequence, the 3 e-mail from Kevin to Alan on June 9th at 4:08 p.m., it 4 begins, we would love to invest more and I even sent an 5 e-mail out a week, or so ago, asking if people we, I think 6 that means were, okay ramping up to 4:1; what does 4:1 7 mean? 8 A The way I understand it is the ratio of our 9 assets to Alan's assets. 10 Q Meaning if he trades $1 you will have $4 11 involved? 12 A Yes. 13 Q The second paragraph begins, I realize that it 14 is tough for you, but I have to believe that we could get a 15 top-notch attorney to draft an agreement that is very 16 binding and also has huge penalties in it if we violate it. 17 It continues, Chao and I could agree to not 18 share your info with any of our colleagues or anyone else, 19 could agree never to participate in UTC trading with anyone 20 else, et cetera? 21 Next sentence: Make it restrictive and give it 22 teeth and we will sign it. To the best of your knowledge 23 is he referring to you in that when he says Chao? 24 A Yes. 25 Q And what is he -- to the best of your knowledge 31 1 as you sit here right now reading this e-mail, what is he 2 referring to in these couple of sentences? 3 A You want me to say how I understand this e-mail? 4 Q Yes, how do you understand this to read? I 5 understand that you were not a direct recipient of this 6 e-mail. 7 A Right. You want an understanding outside of 8 what it says? 9 Q Let me put it to you better. Around this time, 10 the summer of 2009, do you recall discussing an agreement 11 with Alan Chen? 12 A I actually do not. I mean I read this e-mail, I 13 know I am cc'd on it. I mean my involvement has been very 14 peripheral, like I am not the one structuring the 15 agreement. Basically Kevin pulls me in if he wants some 16 advice on something, so all of these flow into my mail box. 17 I mean I am not disputing that this happened, I am just 18 saying I can't add very much outside of what is in the 19 e-mail. 20 Q That is fair. 21 MR. McSWAIN: I think you might have misspoken. 22 Are you cc'd on this? Are we looking at Exhibit 210, is 23 that what -- 24 MR. OWENS: Yes. 25 THE WITNESS: Oh, I am not cc'd, okay. So okay, 32 1 but I mean -- 2 MR. McSWAIN: He is just asking you to read it 3 now, and if you have any additional thoughts on it. 4 THE WITNESS: Okay, so I am not cc'd on it, but 5 I mean, I read it the way you read it. 6 BY MR. TABACKMAN: 7 Q Did you have any conversations that you can 8 recall with Kevin Gates about having an agreement, trying 9 to get an agreement set up with Alan Chen and what that 10 might look like? 11 A Yes, we talked about trying to get more 12 information out off him about his trading, that we were 13 always trying to find out about other people's strategies 14 knowing that most of them aren't going to tell you anything 15 anyway. 16 Q Had you and Kevin talked about having this very 17 restrictive nondisclosure agreement, that this might be 18 something of a strategy to try to get Alan to agree to give 19 you more information, did you talk about that with Kevin? 20 A Yes, I remember we tried to ask him to sign an 21 NDA or -- 22 BY MR. OWENS: 23 Q Do you recall entering into an NDA with Alan 24 Chen? 25 A I don't remember. We could have, but I don't 33 1 remember. 2 MR. OWENS: This is Exhibit 250. 3 (Chao Chen Exhibit 250 identified.) 4 BY MR. OWENS: 5 Q While the witness is reviewing this, Exhibit 250 6 is Bates marked POW7257. It is an e-mail from Greg 7 Sekelsky to Kevin Gates Re: NDA with Alan Chen. The 8 e-mail was sent on August 4th, 2010, it contains an 9 attachment that begins on POW7259, dated July 3rd, 2009. 10 MR. McSWAIN: Do you want him to read the whole 11 document or -- 12 BY MR. OWENS: 13 Q No need to read the whole thing, but as much as 14 he wants to to familiarize himself with it? 15 A Okay, I am done. 16 Q If you would look to the last page, POW7261, 17 page 3 of the attachment, I think you will see what appears 18 to be Alan Chen's signature as well as Kevin Gates' 19 signature, and the handwritten date 7/3/09; is that 20 correct? 21 A Yes. 22 Q If you would turn to the previous page, page 2 23 of the attachment, POW 7260, fourth full paragraph 24 beginning, HEF agrees that it will not share HEEP's 25 Confidential Information. That sentence continues with, 34 1 any representatives of HEF besides Chao Chen and Kevin 2 Gates. Chao and Kevin will use reasonable care to ensure 3 that other representatives of HEF are not given HEEP's 4 Confidential Information, moreover, HEF agrees not to 5 invest in Up To Congestion trading at PJM at any point 6 while HEEP is trading HEF's account, either directly or 7 indirectly, without the express written consent of HEEP. 8 Did I read that accurately? 9 A Yes. 10 Q HEF, H-E-F, does that refer to Huntrise Energy 11 Fund to the best of your knowledge? 12 A I believe it does. 13 Q And so this agreement, this is an NDA, appears 14 to be; is that correct? 15 A Yes. 16 Q So you and Kevin are the only partners at 17 Huntrise who are given access or to be given access to 18 Alan's information in exchange for this broader agreement; 19 is that correct? 20 A Yes. 21 Q Do you remember speaking with Kevin about being 22 the other partner at HEF who is part of this NDA? 23 A I remember talking to Kevin about the NDA, I 24 don't know the details of what was written here. I don't 25 know the details of what was written in the NDA, but it 35 1 agrees with what I remember. 2 Q To the best of your understanding why did Kevin 3 ask you to be the other partner or party to this NDA? 4 A Why did Kevin want me to be the other party? 5 Q Why did Kevin want you to be the other, I should 6 say partner, at HEF who has access to Alan Chen's 7 information? 8 A Well, I don't know exactly why he wanted me to 9 be the other half, but if I had to guess, I would say he 10 trusted my opinion, judgment. 11 Q Thank you. Did you two discuss this issue? 12 A Yes, I think so. 13 Q And that was your take away from your 14 discussions with Kevin, that is not pure speculation then, 15 he trusted your judgment, you think? 16 A I don't know if we said it exactly that way, but 17 that is my take. 18 Q Did you have any conversations with Alan Chen 19 after your dinner in October of 2008, up to and including 20 the day when this NDA was signed? 21 A When was the dinner? 22 Q The dinner was, if you look back -- 23 A October '08? 24 Q October 2008, and this is July, this attachment 25 you will see is dated July 3rd, 2009, so anytime between 36 1 October and July do you recall having any communications 2 directly with Alan Chen? 3 A I remember being on a phone call with Alan and 4 Kevin, I don't remember when that was. 5 Q What was discussed during that phone call? 6 A The same, just, you know, more strategy stuff. 7 We tried to talk about what, you know, how he is doing 8 trading. 9 Q After entering into this agreement do you recall 10 Huntrise expanding its relationship with Alan Chen? 11 A At some point after this agreement I remember we 12 started, he started trading more money for us, yes. 13 Q Do you recall having a meeting with Alan Chen 14 after this agreement was signed? 15 A Yes. 16 Q Do you recall approximately when that meeting 17 was held? 18 A Well, I saw the e-mails from before so I think 19 it is in June of 2010. 20 (Chao Chen Exhibit 213 identified.) 21 BY MR. OWENS: 22 Q For the record, Exhibit 213 is Bates-stamped 23 POW17061. It is an e-mail from Kevin Gates to Alan Chen 24 with copy to Chao Chen, dated July 14th, 2009. 25 Does this refresh your recollection, did you 37 1 have a -- recall any meeting in July 2009 with Alan Chen? 2 A Actually, I don't. I remember having dinner 3 with him the first time that we talked about it at Hunan 4 restaurant, and another time he at the office, I believe 5 that was 2010. I don't remember a third meeting or this 6 one, I mean, I am not that clear on the date. Again, it 7 was kind of a long time ago. 8 Q Okay. Sometime in the fall of 2009 do you 9 recall hearing about something called Transmission Loss 10 Credits or TLC's? 11 A I remember hearing about TLC's, I am sorry, like 12 the time is hard for me to pin down, but it was after we 13 started trading with Alan, you know, we gradually learned 14 things like UTC and TLC's. 15 Q To your knowledge today what is a TLC? 16 A To my understanding of TLC is that it is called 17 Transmission Loss Credit, and that PJM pays you a TLC if 18 you trade in the UTC market, and I understand that it is 19 based on how many megawatts hours you trade, so 20 proportional to the megawatt hours you trade that PJM will 21 pay you to a credit to trade. 22 Q Do you know what a transmission loss is? 23 A I believe that is something you have to pay when 24 you put on a trade in the UTC. 25 Q After this NDA was signed, do you, did you 38 1 obtain better information, more specific information from 2 Alan Chen regarding his UTC trades? 3 A Like I said, we continued to learn more from him 4 and we did learn more things after the NDA was signed. 5 BY MR. TABACKMAN: 6 Q Are you familiar with the term Oasis? 7 A Yes. 8 Q What is your understanding of Oasis? 9 A I think that is a name of the software or the 10 system that you go on to make the UTC trade. 11 Q I don't mean to make a fine distinction. You 12 said that you pay based on how much you trade; do you know 13 whether it is how much you trade or how much you reserve 14 for possible trading? Does that distinction mean anything 15 to you? 16 A I don't know exactly how the market works. I 17 don't know, for example, whether you get charged -- well, I 18 think you only get charged -- so, my understanding of UTC 19 is that you either, you can bid on stuff, and you either 20 get the bid or not like at an auction, I can bid on 21 something I may or may not get it. I think you only get 22 charged if you get it. But I know there is a concept of 23 reservation, but to me that is the extent of my knowledge 24 of how this stuff works. 25 MR. McSWAIN: Could we take a five-minute break 39 1 have been about an hour? 2 MR. OWENS: Sure. 3 (2:46 p.m. -- recess -- 3:00 p.m.) 4 BY MR. OWENS: 5 Q Do you recall the, when the TLC's started coming 6 in -- well, let me back up for a second. How much money 7 did you invest in, I guess it would be Huntrise Energy 8 Fund? 9 A I don't know the dollar amount. I invested 10 10 percent of the total, I believe. 11 Q And without having to guess a dollar amount, 12 would that have been a significant amount of money for you? 13 A I guess I can guess the amount. I mean the fund 14 had what, a million it in. 15 Q For the sake of argument, it had a million? 16 A Then I would have had 100,000. 17 Q Did you review the P & L statements that were 18 circulated around? 19 A I did not. 20 Q Why not? 21 A Because I was busy doing other things, you know, 22 and we had other investments. We had -- for whatever 23 reason we have a bunch of equities that we are all invested 24 in, so that is just not something I am interested in. To 25 track the P & L, plus I trust everyone that is doing it. 40 1 So I know Kevin sent a statement or P & L figures, but I 2 mean, I did not track those too closely. 3 Q Do you recall beginning in late 2009 that the 4 TLC numbers started showing up in the P & L statements? 5 A I remember Kevin saying that the TLC's are, that 6 PJM started paying TLC's or TLC's are coming in, a lot of 7 them. 8 Q Do you remember the magnitude of these payments? 9 A I do not, I don't know the dollar amount of the 10 TLC's, but I know the fund made a lot of money. 11 (Chao Chen Exhibit 216 identified.) 12 BY MR. OWENS: 13 Q For the record, Exhibit 216 is 14 Bates-stamped POW8242, it is an e-mail from Kevin Gates to 15 Rich Gates, Eric Newman, Chao Chen, Larry Eiben with a copy 16 Greg Sekelsky and Kevin Gates, dated September 8, 2009. 17 A Okay. 18 Q So this e-mail begins, we only had Alan trading 19 last month, and he lost about 30K from his trading, but we 20 were just reimbursed for a lot of transmission losses that 21 we were previously charged from the trading but shouldn't 22 have been. And I do mean a lot, 440,000ish, so net-net we 23 made 410,000 last month. Do you recall receiving this 24 e-mail? 25 A I don't. I mean I don't remember the e-mail but 41 1 now that I read it, I mean I believe it for, I have no 2 reason to doubt that he wrote that e-mail and that I 3 received it. 4 Q Does this refresh your recollection on the 5 magnitude of the TLC's that were coming in? 6 A I believe what he is saying here, I mean I don't 7 know if I appreciated the exact dollar amount back then. 8 Q Do you recall being surprised at the amount of 9 money that was being sent over? 10 A I was happy. Surprised, I -- no, I guess I 11 didn't know what to expect, you know. I am not following 12 these, the trading, and the figures outside of these 13 e-mails from Kevin, so -- and I tend not to, to me it is, 14 you know, invest with lot of people and you can make a lot 15 of money and lose a lot of money, even with my own 16 investments I try not get too hung up on the day-to-day 17 numbers. 18 Q Now, under the NDA that Kevin signed with Alan 19 Chen, you and Kevin are one of the, for lack of a better 20 word, insiders, who theoretically have access to Alan's 21 information? 22 A Yes. 23 Q During this period of time when the TLC's 24 started coming in did Kevin reach out to you and discuss 25 the TLC's with you at all? 42 1 A Yes, I remember him saying that the TLC's are 2 big, and that they contribute to most of the profits. 3 Q Did he have any questions, concerns? 4 A For me? 5 Q That he expressed to you about the TLC's? 6 A Not that I recall. 7 Q Do you recall looking into the TLC's, 8 researching them? 9 A I did not. 10 Q Exhibit 219. 11 (Chao Chen Exhibit 219 identified.) 12 BY MR. OWENS: 13 Q For the record, Exhibit 219 is POW7936, e-mail 14 from Kevin Gates to Rich Gates, Eric Newman, Larry Eiben 15 and Chao Chen dates March 5th, 2010. 16 A Okay. 17 Q In this e-mail Kevin writes that since inception 18 Alan has made almost $3.6 million in our account of which 19 Huntrise keeps 60 percent or $2.1 million. Then he notes 20 that $2.1 of the $3.6 that Alan made was in the form of 21 Transmission Loss Credits. 22 He then relates, in an e-mail that Alan sent to 23 me today he said quote "the bad thing is it really concerns 24 me: If PJM ever reverts back to those days without TLC or 25 the TLC calculation was/is incorrect and we have to pay 43 1 back all or some of the TLC refunds we are going to be in 2 big trouble. I have not heard anything about this at all, 3 but just the thought nags me a lot," unquote. Do you 4 recall receiving this e-mail? 5 A I don't. 6 Q Do you recall having any conversations with 7 Kevin Gates or anyone else about the prospect that the TLC 8 money might have to be refunded? 9 A Yes. 10 Q What do you recall of this conversation? 11 A Similar idea as here, basically we are getting 12 paid a lot of TLC's and it might not last forever. 13 Q Do you recall approximately when you had the 14 first of those conversations? 15 A I don't remember. 16 Q In your other trading had you ever encountered a 17 situation in which large refunds, refunds along the lines 18 of this magnitude are coming into your fund? 19 A What do you mean by refund? 20 Q Refund or credit such as the TLC, that 21 subsequent to the trading that some amount of money is 22 credited to the account, more than, greater than just the, 23 what you experience from the trading itself? 24 A So we always thought of the TLC's as part of the 25 trading, not subsequent to the trading, and in other areas 44 1 of our trading we have taken advantage of such 2 opportunities in the equities world where the trading is 3 very profitable. 4 Q What type of trading in the equities world have 5 you taken advantage of, what types of rebates have you 6 used? 7 A I am a little uncomfortable with talking about 8 strategies, I don't know if that is appropriate to -- 9 MR. McSWAIN: You can talk about it in general 10 at a level that you are not going to be giving away any 11 things that are proprietary. He is asking, I think, what 12 you are asking about are what other potential income 13 streams are out there that would be analogous to this. 14 MR. OWENS: That you have taken advantage of. 15 MR. McSWAIN: Without talking specifically how 16 you capture it. 17 THE WITNESS: Yes, but you are saying something 18 we have done and could be doing now, so that is why I am 19 uncomfortable. 20 BY MR. OWENS: 21 Q I don't need dates, just anytime in the last few 22 years you have received rebates. I understand some stock 23 markets whether provide rebates based on volume of trades? 24 A Yes. 25 Q Is that correct? 45 1 A Yes. 2 Q And -- 3 A So let me take that example, and this is in -- 4 well, so -- 5 MR. McSWAIN: Maybe you can think about examples 6 without necessarily tying to it your -- 7 THE WITNESS: Okay, this one is related to 8 trading of TFS -- 9 BY MR. OWENS: 10 Q I don't want to keep it purely hypothetical or 11 theoretical? 12 A So TFS trades about $100 million a day. We have 13 mutual funds in the market, the Market Neutral Fund trades 14 about, my estimate is $100 million a day. And that maybe 15 $10 million a shares. 16 Q Okay. 17 A And on some exchanges, you know, when these 18 stocks are traded you get paid provided liquidity, which 19 means if you submit an order that says I would like to buy 20 a stock another $10, buy IBM at $10 and somebody takes that 21 offer, you get paid a fee, a rebate, it is actually called 22 a rebate. 23 So when we route our orders, now, we don't do 24 this ourselves, we are not putting in out orders ourselves, 25 but we route our orders to our broker. We have a broker 46 1 where we will route 10 million shares to the broker, and 2 the broker earns a rebate if they submitted the order that 3 way. And so because of this rebate the broker charges us 4 less money. 5 So indirectly there we are benefiting from a 6 rebate purely for trading and not because of price or 7 something we bought just going up. 8 Q So, generally speaking, these rebates in the 9 stock world, they serve to reduce your transaction costs by 10 some amount, but they don't eliminate them altogether? 11 A Well, they don't eliminate TFS Capital's 12 transaction costs, definitely not, but they eliminate the 13 broker's transaction costs. So, if you are -- we are not 14 able to, we are not a broker so we can't put an order 15 out -- well, I don't know if we can or cannot; we do not. 16 But if you have the ability to submit these orders and 17 somebody takes that order, you do get paid, somebody pays 18 your transaction costs or you have a negative transaction 19 cost. 20 Q So your understanding is these rebates will pay 21 all of your transaction costs or indeed, create a profit 22 over and above the transaction costs? 23 A Yes, my understanding is typically if you are an 24 individual and you want to buy a share of IBM, you go out 25 to the market and you pay $100 for it and you pay your 47 1 broker $10, right. So now you own a share of IBM that you 2 could sell at $100 but you paid $110 for it, so the $10 is 3 transaction costs. 4 If you are someone who is able to submit this 5 kind of limit order to an exchange that pays a rebate and 6 you say I want to buy IBM at $100 and somebody happens to 7 take that order, the result of that is that you paid less 8 than $100 for the shares at IBM because you paid $100 to 9 the guy that sold it to you, and the exchange paid you one 10 penny or half a penny. 11 Q All right, sir. And your understanding is these 12 rebate mechanisms exist, are created by the markets in 13 order to promote liquidity? 14 A They are created by the markets, and why exactly 15 they do, I can't say. 16 (Chao Chen Exhibit 221 & 222 identified.) 17 BY MR. OWENS: 18 Q 221 is Bates marked POW8000. It is an e-mail 19 from Kevin Gates to Rich Gates, Eric Newman, Larry Eiben 20 and Chao Chen dated March 19th, 2010. 222 is the 21 attachment to the e-mail, Bates number POW8001, entitled 22 Rampin' up with Alan Chen, Kevin Gates, March 19, 2010. 23 Just let me know when you have finished 24 reviewing the documents. 25 A Yes, I have reviewed them. 48 1 Q Do you recall receiving this e-mail from Kevin 2 Gates? 3 A I don't recall receiving the e-mail but I see it 4 in front of me, so. 5 Q Have you ever reviewed it before, this e-mail or 6 the attachment? 7 A I don't remember, but I -- I think I would have, 8 if I received it, yes, and the attachment. 9 Q The e-mail itself with a cover e-mail, that is 10 to say, Exhibit 221, Kevin states, it is too exciting and 11 we need to have a lot of exposure this Summer, and it 12 states, Alan Chen's trading. Larry and I are working to 13 create a new partnership that we can each invest directly 14 in and hope to have this set up before the summer months 15 which are typically profitable. 16 In your understanding, why would Larry and Kevin 17 want to create a new partnership to invest in Alan's 18 trading? 19 A My understanding is we create a partnership to 20 invest in outside managers. 21 Q I understand, but aren't -- isn't it correct 22 that all of you are already invested in Alan's Huntrise 23 Energy Fund? 24 A We were, yes, we were invested through Energy 25 Fund. 49 1 Q So to the best of your understanding, why new 2 partnership? 3 A Why a new partnership? It is -- I believe it is 4 for legal reasons but, you know, I am not the one setting 5 these things up. So I just agreed with however Kevin and 6 Larry thought that the structure was different or had to 7 be. 8 Q Did anyone other than an attorney explain the 9 legal reasons, I am not sure what that means? 10 A Well, I believe, I mean we have entities for our 11 mutual funds and hedge funds, I mean, I don't -- 12 MR. McSWAIN: I don't think he is asking you to 13 speculate, it is just what do you know. If you don't know, 14 you don't know. If you know, go ahead and answer his 15 question. 16 THE WITNESS: To the best of my knowledge it is 17 for legal reasons, outside of that I can't say. I am not 18 an expert on these. 19 BY MR. OWENS: 20 Q If you turn to 222, start at page 2, Executive 21 Summary; is that correct? 22 A Yes. 23 Q Second bullet point beginning, PJM just changed 24 things, Kevin writes, Basically UTC traders don't have to 25 pay transmission losses anymore. This creates more 50 1 opportunities for Alan, but Alan is fearful that PJM could 2 change its mind and could force UTC traders to pay TLC's. 3 Do you recall having any discussions with 4 anybody about this prospect, this fear that these fees 5 would have to be refunded? 6 A Yes, I remember we knew that we were making 7 money on the TLC's and we were aware that this won't last 8 forever. 9 Q Why were you aware it wouldn't last forever? 10 A Because it is too big of an opportunity. It was 11 a good -- anytime we make a lot of money finding any trades 12 we feel that eventually other traders will see the same 13 opportunity and arbitrage that away. 14 Q So you thought that it would go away if other 15 traders began to get into the market and reduce the TLC's; 16 is that correct, is that a fair -- 17 A Just in general, the better the opportunity is 18 the more likely that it will go away. You know, I say that 19 because it just comes from a general belief that arbitrage 20 opportunities don't last forever. 21 Q Too good to be true? 22 A The question? 23 Q Is that the sense that you are getting at, it is 24 too good to be true so it won't last? 25 A Again, when an opportunity is big enough there 51 1 are arbitrageurs that will come and take it away, in 2 general. If there is a dollar lying on the ground it is 3 not going to be there for too long. So, we think of -- it 4 is not just in power trading, that is in any kind of 5 trading, you spot an opportunity and you think that other 6 people would see it, too. 7 Q But if you look at the second line of that 8 bullet I just read to you, the sentence beginning but; but 9 Alan is fearful that PJM could change its mind and force 10 UTC traders to pay TLC's. That is not really other 11 arbitrageurs taking advantage, right, that is more of a 12 regulatory change; right? 13 A Sure. 14 Q And the last line reads, he feels that way 15 because it is just too easy for him to make money now. So 16 this -- that is consonant with the concern you were just 17 expressing? 18 A Yes. 19 Q Turn to page 3, please. You will see a short, 20 well, I guess there are three sentence that at the top, and 21 then a chart that runs from zero to 80,000 on the Y axis 22 and the date on the X is from September 2007 to March 2010, 23 and it looks to me as if this is a, either volume or money. 24 You have separate charts for HEEPF and Huntrise, and it 25 looks, if that is correct, it looks like starting after 52 1 January 2010 this number skyrockets; is that a fair 2 testament of the chart? 3 A The top line goes from 20,000 to about 70,000. 4 Q At the top Kevin writes, Alan's exposure has 5 significantly ramped up. Alan maintains that his account 6 parens (HEEPF) close parens, isn't taking much more risk... 7 which he describes as almost a risk free way to make money. 8 Did you have any discussions with anyone about 9 Alan's TLC trade, in fact, to the best of your 10 understanding what does TLC trade mean? 11 A What does TLC trade mean to me? 12 Q Yes, what is your interpretation of that phrase, 13 TLC trade? 14 A My interpretation that it means that Alan's 15 trading, it is just a shorthand to describe Alan's trading, 16 of which TLC is a part. 17 Q And almost a risk free way to make money, did 18 you have any communications with Kevin or anyone else about 19 Alan's risk free way to make money? 20 A Well, this is the communication, I mean Kevin 21 wrote those words. 22 Q Aside from this, do you recall any discussions 23 about Alan's new TLC trade and the relative risks or lack 24 thereof in making money? 25 A We talked about the fact that the TLC is being 53 1 paid by the PJM, and that that was, we are collecting the 2 TLC's. I don't recall saying or talking about the fact 3 that it, or talking about risk free or not risk free, but I 4 never believe something is risk free, right? 5 So I mean, this is an internal communication and 6 you know, I don't know what makes him write what he writes, 7 but in the investing world you always are trying to 8 minimize the risk, but I don't think it makes sense to 9 think of something as risk free. 10 Q Will you turn to page 5. The narrative at the 11 top of the slide reads, Alan is now actively altering his 12 trading to profit from the TLC. Were you aware at that 13 time that Alan Chen was doing this, was actively altering 14 his trade to profit from the TLC? 15 A I don't know how Alan trades, I have never seen 16 his trades. So whatever I know about the trading I get 17 from Kevin, from either talking to him or communications 18 like this, and my understanding was yes, we were collecting 19 the TLC's and that was contributing to our profits. 20 Q And so if we look back to the previous summer 21 you were one of the parties named in the NDA such that you 22 and Kevin would have access to Alan's trading secrets? 23 A That is right. 24 Q Are you saying as of March of 2010, so roughly 25 nine months later, you hadn't picked up those secrets, or 54 1 you were not part of those conversations? 2 A I haven't picked -- in all of my dealings with 3 Alan I haven't picked up any secrets from him. He -- well, 4 what is a secret? So he told us how the UTC works, 5 gradually we learned there is UTC, after that there is a 6 TLC. I mean I don't know if you consider those secrets, 7 but I mean I am kind of -- I am not disputing what you are 8 saying here that, you know, I realize we are collecting a 9 lot of our profits from the TLC. 10 Q Well, in fact it looks like, if you read the 11 next sentence, last month we would have lost almost 12 $400,000 if not for the TLC, but we netted a profit of more 13 than $200,000? 14 A That is what it says. 15 Q So it appears that not only the bulk of your 16 profits but all of your profits are coming from the TLC's 17 by this point? 18 A For that month, yes. 19 Q Did that concern you in any way that Alan's 20 trading appears to be losing money except for the receipt 21 of these credits? 22 A No, not at all, overall it was making money. We 23 didn't see the TLC as being a separate part from the rest 24 of the trading. So basically the trade has four components 25 to it, the day ahead, real-time, the TL and the TLC, so 55 1 taken together those make up your profit and loss, that is 2 my understanding, I don't know if there is any other term 3 in there. 4 So when we make trades we want to make money 5 after all those numbers are summed together. It doesn't 6 make sense for us to separate out one components. 7 BY MR. TABACKMAN: 8 Q Do you have any understanding as to why, when 9 Alan presented these figures he separated out the PnL from 10 the TLC? 11 A He presented these to -- 12 Q When he presented the numbers, I believe it was 13 on February and in the March presentation, he refers to the 14 amount of money that was made on the PnL, on the 15 transaction itself, and then the amount of money that was 16 made on the TLC, which, and you were saying you looked at 17 it as a whole. Do you know of any reason why Alan would 18 have looked at it any differently? 19 MR. McSWAIN: Are you talking about e-mails that 20 Alan sent to -- 21 MR. TABACKMAN: Yes, e-mails. I am sorry, I 22 thought you had that in front of you there. I apologize. 23 (Discussion off the record.) 24 (3:31 p.m. -- recess -- 3:40 p.m.) 25 BY MR. OWENS: 56 1 Q Mr. Chen, if we could look back to Exhibit 219 2 quickly, I would like to direct your attention to the 3 closing sentence of Kevin's e-mail. That reads, Also, 4 maybe we could have an attorney, or someone, really dig in 5 the TLC's on the UTC trade. 6 I may have already asked you this, but since we 7 are going back on this to be certain; do you recall 8 receiving in e-mail? 9 A I don't, but I see it and I accept that I did 10 receive it. 11 Q Do you recall having any discussions outside 12 this one e-mail about seeing if an attorney could look into 13 the TLC from the UTC trade? 14 A I don't remember talking about attorneys for the 15 TLC. 16 Q Do you recall any legal concern about the TLC's? 17 A I don't. 18 (Discussion off the record.) 19 BY MR. OWENS: 20 Q Mr. Chen, do you recall any other instance in 21 which Kevin expressed concern or a desire to have an 22 attorney look into particular investments? 23 A That is really general, so can you repeat the 24 question? 25 Q Sure. I can be more specific, too. In this 57 1 e-mail, the last sentence of this e-mail, Kevin expresses 2 or suggests that we, meaning you, Kevin, Rich, Eric and 3 Larry, might want to have an attorney or someone, I think 4 the quote is, "really dig into the TLC's on the UTC trade," 5 unquote. Do you recall any other instance where Kevin or 6 anyone else, any of the other partners, expressed a similar 7 concern with a different kind of investment? 8 A I don't recall, but if you ask me specifically 9 about some investment maybe I can -- 10 Q No, that is fair. If you don't recall, you 11 don't recall. 12 A Yes, I don't recall. 13 Q Let's publish this exhibit to the witness, this 14 one requires stamping, it will be 251. 15 (Chao Chen Exhibit 251 identified.) 16 BY MR. OWENS: 17 Q I have just handed you Exhibit 251, it is Bates 18 labeled POW7998. It is an e-mail from Rich Gates to Kevin 19 Gates, with a copy to Eric Newman, Larry Eiben and Chao 20 Chen on March 20th, 2010. Let me know when you have had a 21 chance to review it. 22 A I have. 23 Q I think you will agree that the first e-mail 24 chronologically in this thread is the cover e-mail that is 25 Exhibit 221? 58 1 A Yes. 2 Q And so this is Rich Gates' response the next day 3 to Kevin's e-mail. And if you would look at, there are 4 three numbered paragraphs in Rich's e-mail, paragraph 5 numbered 2 reads, I would make sure our agreement with Alan 6 covers us in the case that we are retroactively charged a 7 fee... so that we can then go after Alan and ask him for 8 our money back; is that correct? 9 A Yes. 10 Q Do you recall receiving this e-mail? 11 A I don't recall but I believe that I did, now 12 that I see it. 13 Q Does this reference this concern that Rich 14 voices about being retroactively charged a fee, does that 15 refresh your recollection about retroactive reimbursement 16 that might be required, discussions that occurred on or 17 around this time, March of 2010? 18 A Can you -- my question is -- can you ask that 19 question again? 20 Q Sure. Reading this e-mail now, does this help 21 refresh any recollection you might have of discussions 22 among your partners concerning the risk that you might be 23 charged retroactive fees based on Alan's trading? 24 A I know what you are saying. So, we were never 25 certain that the PJM would not decide to change the rules 59 1 retroactively, so that was a concern. So basically PJM 2 paid us $3 million or whatever it was, but we thought there 3 was a chance they would change the rules and take that 4 money back. 5 Q When you say we, are you referring to Kevin 6 Gates, Rich Gates, do you recall who specifically discussed 7 this concern with you? 8 A I don't remember who originated that but I think 9 it is a natural concern. 10 Q Why is it a natural concern? 11 A Because PJM is, they set the rules, so if they 12 set the rules one way, they can change it the next day. We 13 don't trust them to not do that, and I don't know if there 14 has been other cases where they have retroactively changed 15 the rules, maybe that is a little paranoid, but we don't 16 know how this market operates. 17 Q And your concern about retroactive changes to 18 the rules, is that specifically in reference to the TLC's, 19 that is to say, your concern that PJM might retroactively 20 change the rules, is what you really mean there, your 21 concern is they might retroactively change the rules with 22 respect to the TLC's that are being paid to you? 23 A Well, so I can only talk in general about this 24 concern that we know we made profits from the trading based 25 on one set of rules, and if they decide to change that, 60 1 those rules, that could impact our profits. So TLC is part 2 of, part of the rules. 3 Q Paragraph 3, the numbered paragraph 3, that is 4 to say, reads, I am glad we have sent a pile of money on 5 top-notch lawyers to make sure that the new partnership is 6 separate and distinct from everything else we have done... 7 ellipses, and to protect us in other ways with this 8 investment. What is your understanding of this last 9 clause, and to protect us in other ways with this 10 investment? 11 A You want my interpretation of what Rich wrote? 12 Q Your interpretation as -- well, let's back up 13 and just, do you recall the discussions on or around this 14 time setting up a new partnership and finding ways to 15 protect yourselves with this new investment with Alan Chen? 16 A Yes. 17 Q What were those discussions, what did those 18 discussions concern? 19 A The same concerns we have with every investment 20 in every partnership, we want to protect yourselves. So, I 21 mean, I am not the one hiring the lawyers and I, before I 22 saw that I didn't realize that we did hire lawyers. I mean 23 it is natural to want to protect yourselves. 24 Q To the best of your understanding why was it 25 important to make sure that the new partnership is separate 61 1 and distinct from everything else you have done? 2 A Why did Rich want this partnership to be 3 separate and distinct? 4 Q Well, as you read this, why, what is your 5 interpretation of that? 6 A Well, my understanding is if I wanted to protect 7 one investment from another investment I would keep them 8 separate. 9 Q What does it mean to protect one investment from 10 another investment? 11 A Well, for example, when I -- I think when I buy 12 a house and I get a mortgage, my retirement account is 13 protected from the event I default on a house, on the 14 house, that is my understanding of how the law works. I am 15 not a lawyer but I know there is a lot of laws protecting 16 personal property against seizure or collection, and I 17 think it is all related in the same idea that, to the 18 extent as much as possible I want to protect my retirement 19 account from the event that I lose my house. 20 Q A few weeks before this e-mail Kevin had 21 explained in some exhibits we saw, explained something 22 along the lines of $2.1 million of the profits you received 23 from Alan Chen's trading came in the TLC payments? 24 A Yes. 25 Q Would that be part of this concern about 62 1 protecting your new investments, your different 2 investments, if there is a retroactive change in the rules? 3 A It is hard for me to answer. Would we be 4 protecting the $2.1 million? 5 Q Or your other assets, potentially? 6 A We want to protect every asset we have, and I 7 think the electricity is not the only entity we have set 8 up, we have other entities for investments. I think that 9 is a common practice. 10 Q Do you commonly create, in this particular case 11 you already had one fund that was already invested with 12 Alan Chen; correct, Huntrise Energy Fund? 13 A Yes. 14 Q Around this time it was decided to close that 15 fund and create the Powhatan fund that would also be 16 invested in Alan? 17 A Yes. 18 Q Is it, I understand that you have different 19 special purpose funds for different kinds of investments. 20 Is it common to close one fund and create a new fund 21 dedicated to the same investment just to change the title 22 and the -- 23 A Sure. As we learn more and more about how to 24 structure entities and about the law and talk to more and 25 more lawyers, we end up paying more and more lawyers to set 63 1 up entities. I mean, that is how we understand, you know, 2 our idea of what is the right way to set up an entity 3 evolves. So that is the reason why we would close one fund 4 and open another fund, even though we are investing in 5 electricity in both funds. It has nothing to do with the 6 trading itself but the law, I assume. 7 Q So you are not necessarily privy to these 8 discussions, these -- 9 A I am not. 10 Q So these are discussions that Kevin and Rich and 11 Larry tend to take charge of? 12 A That is right. 13 Q Do you recall having a meeting with Alan Chen in 14 the summer of 2010? 15 A Yes. 16 Q When, approximately was that meeting? 17 A June. 18 Q Do you know why that meeting was called? 19 A Same reason why we called the other meeting with 20 him, to learn about his trading. 21 Q Do you recall losing -- do you recall Alan Chen 22 losing a lot of money for Powhatan in May of 2010? 23 A I wouldn't have recalled it unless I read the 24 e-mails, which I did last week, so now I realize he lost 25 the money. 64 1 Q So you, at the time you weren't paying attention 2 to the P & L statements that were being circulated? 3 A That is right. 4 Q Did you participate in the meeting with Alan? 5 A Yes. 6 Q Who else was at this meeting? 7 A I was there, Alan was there, I believe Kevin was 8 there, and I don't think anybody else would have been 9 there. 10 Q Did you -- you said before for your 2008 meeting 11 that you had picked Alan up from the airport; did do you 12 that for this meeting as well? 13 A I don't think I did that. I met him at the 14 office, I think that is when I first saw him that time, in 15 June of 2010. 16 Q Do you recall if that was during the business 17 day or after hours when you met Alan the first -- the first 18 time you saw him at the June meeting? 19 A Yeah, it was during the business day, in fact, 20 it was a memorable day because we lost power that day in 21 the office, so we were supposed to meet earlier but we 22 didn't meet until about 11:00, because nobody could get in 23 the office or nobody had a reason to go to the office. 24 Q Do you remember having dinner with him the night 25 before? 65 1 A I do not. 2 (Chao Chen Exhibit 230 identified.) 3 BY MR. OWENS: 4 Q For the record, Exhibit 230 is Bates labeled 5 POW16828, and it is an e-mail from Chao Chen to Kevin Gates 6 with a copy to Alan Chen on June 23, 2010. 7 A Okay, I just read the top part. 8 Q Does this help refresh your recollection about 9 dinner? 10 A A little, yes. 11 Q Did you -- just for the record, this e-mail from 12 you reads, let's have dinner in West Chester, my 13 sister-in-law is in town so I don't want to go too far? 14 A That is what it says. 15 Q So you did in fact end up having dinner? 16 A I think so. 17 Q Do you recall who else was at the dinner? 18 A To the best of my memory it was me, Alan, Kevin 19 and maybe Kevin Byrnes. 20 Q Who is Kevin Byrnes? 21 A Guy who works in the office. 22 Q How do you spell his last name? 23 A B-y-r-n-e-s. 24 Q What does Kevin do? 25 A He is an analyst. 66 1 Q How long has Kevin worked for TFS? 2 A About two years now. 3 Q So he joined TFS in the spring of 2010? 4 A Either at the beginning of '10 or the end of 5 '09. 6 Q And when you say analyst, what does that mean? 7 A He does research on strategies, trading 8 strategies. 9 Q Does he have any particular expertise with the 10 energy markets? 11 A Well, we took him out to dinner with Alan 12 because he had an internship at Constellation, which is an 13 energy trading company, I don't know if they are a utility 14 or a pure trading company, but he had an internship while 15 he was student. 16 Q When you say he had an internship that makes me 17 think he was fairly young when he started with you? 18 A He turned 30 last year. 19 Q So it depends on -- 20 A Yeah -- 21 Q -- my use of the word young? 22 A Yes, he is young. 23 Q So were you getting him up to speed on the power 24 trading business? 25 A No, we just invited him to dinner because we 67 1 knew that he was interested in power and we thought that 2 might be fun for him. 3 Q Aside from ordinary socializing, small talk, 4 did -- do you recall any discussions at dinner about Alan's 5 trade or the UTC trading in general? 6 A I don't think we talked about trading at dinner. 7 Q And the next day you said you met him about 8 11:00 in the offices? 9 A I think so. 10 Q Who met him in the offices? 11 A I think I was there, well, I know I was there 12 and I think Kevin was there. 13 Q Kevin Byrnes or Kevin Gates? 14 A Kevin Gates, Kevin Byrnes was not there. 15 Q So Kevin Byrnes just participated in the dinner? 16 A Yes. 17 Q Is he still employed by TFS? 18 A Yes. 19 Q And what did -- well, for how long did you meet 20 with Alan Chen? 21 A It was a short meeting. I don't remember how 22 long, maybe one or two hours. 23 Q And did Alan give say a PowerPoint presentation? 24 A No, I think we just either drew on a piece of 25 paper or drew on the board. 68 1 Q And what were you drawing? 2 A Oh, I think he was drawing, like trying to tell 3 us about Up To Congestion. I think he might have drawn a 4 blob that represents PJM, and maybe another blob that 5 represents MISO. I don't remember. 6 Q What is MISO? 7 A MISO is another energy marketplace for 8 electricity in the Midwest. 9 Q And did Alan talk about specific nodes that he 10 was trading at? 11 A I don't remember but if he did or not, and if he 12 did I wouldn't remember what they are. I think it was a 13 very general discussion and I don't remember now learning 14 very much from it. 15 Q You had already had discussions with Alan in the 16 past, as we established, and to this point you had about 17 two years of experience with Alan and his UTC trading. 18 What if anything was new in June of 2010? 19 A I can't -- I can't point to anything that I knew 20 after the meeting that I didn't know before. I would say 21 not very much, and it is typical of my dealings with Alan 22 is that I don't learn anything from talking to him. 23 Q Do you recall any discussion about, at this 24 meeting or around that time, about correlated pairs of 25 nodes, trading at correlated pairs of nodes? 69 1 A I don't remember whether we talked about 2 correlated pairs at this meeting. I know that is why we 3 are here and that is why we are getting investigated, but I 4 -- so at some point I became aware that there are 5 correlated pairs of nodes, but at this meeting I don't 6 think I appreciated what they. 7 Q What is your understanding of what a correlates 8 had pair of nodes is? 9 MR. McSWAIN: Understanding today? 10 BY MR. OWENS: 11 Q Well, begin with your understanding at that 12 time? 13 A At that time I think I had no understanding. 14 Today I understand the reason that we are here, and the 15 reason you know why Alan or PJM complained about Alan's 16 trading, my understanding, is that he traded congestion in 17 two directions at the same time. 18 Q And is it your understanding then or today that 19 if you trade congestion in two directions at one time that, 20 assuming the volumes are the same, it would net out to zero 21 on the trade? 22 A I understand if you put a bet on for congestion 23 from A to B and the same bet from B to A, the congestion 24 part nets out, yes. 25 Q And you do you also understand that the 70 1 transaction costs associated with that trading would still 2 have to be paid? 3 A Yes. 4 Q So, therefore, do you understand that that would 5 result in actually a loss at any correlated trade, any 6 matched trade between A to B and B to A? 7 A A loss for who? 8 Q A loss for you, the trader who is putting the 9 money up? 10 A So my understanding of the trading is that I bet 11 on real-time congestion, so if I put a bet on at $20, if I 12 buy at 20, and real-time comes in at 21, I made $1 on the 13 congestion part, and I pay X dollars being transmission 14 losses, and I earned Y dollars in Transmission Loss 15 Credits, that is my understanding of that trade. 16 Q Setting aside the TLC's for a second, if you had 17 A to B, B to A trade that you mentioned a few moments ago 18 in similar, same volume, and you said that would net out to 19 zero in congestion? 20 A Yes. 21 Q You buy at 5 and sell at 10, buy at 10 and sell 22 at 5, equals zero. Then you have transaction costs on top 23 of that, again setting aside the TLC's, and your net would 24 be a negative number, it would be a loss, guaranteed? 25 MR. McSWAIN: Is this a hypothetical or -- 71 1 BY MR. OWENS: 2 Q Well, let's talk about hypotheticals right now, 3 this is a hypothetical, so assuming there are no TLC's? 4 MR. McSWAIN: And you are also assuming 5 hypothetically that you are guaranteed that the trades are 6 going to be accepted? 7 MR. OWENS: I am assuming that the trades are 8 accepted. 9 MR. McSWAIN: Okay. 10 THE WITNESS: Hypothetically, if I have two 11 trades on for congestion in different directions or the 12 same link, and profit and loss comes from the congestion 13 part and the transmission loss part and the TLC is zero 14 then, yes, you would lose money on that trade. 15 BY MR. OWENS: 16 Q Does this discussion refresh any recollection 17 you might have about had the discussion that occurred in 18 June 2010 with Alan Chen? 19 A I still don't think we talked about this exact 20 trade that we are talking about, the fact that we are 21 trading in two directions, this strategy or with that. I 22 don't remember Alan dealing revealing that, either that is 23 what he is doing or not doing. 24 BY MR. TABACKMAN: 25 Q I will represent to you, and I can quote from 72 1 the transcript, that Alan recalls and Kevin recalls 2 specifically focusing on the fact that as Alan described it 3 if there was 100 megawatt trade import and 100 megawatt 4 export, this is that you folks were concerned about this, 5 it would net out to zero, and how would you make any money 6 on that, and seeking an explanation from Alan. Kevin's 7 recollection is I was recall him saying something like, if 8 there is no risk how can you have a reward? Does that 9 refresh your recollection of any conversation that occurred 10 on that day? 11 MR. McSWAIN: Let me just make sure I am clear. 12 Is that coming from Kevin's deposition or e-mail -- 13 MR. TABACKMAN: His second deposition when he 14 talked specifically about, I specifically asked him about 15 how you are going to have a reward if there is no risk. I 16 don't have the deposition here, I think it came very close 17 to the end of the deposition. 18 MR. McSWAIN: Okay. 19 BY MR. TABACKMAN: 20 Q So the focus being on this issue of explain us 21 how we are going to make money on a trade that, on these 22 back and forth trades such as you described, and the 23 inferences that I have drawn, at least from Alan's 24 testimony, was a concern that, you know, these trades 25 didn't make a lot of sense in some ways. Was that 73 1 something that you recall pressing him on? 2 A I don't recall remember knowing about this 3 offsetting trade from Alan. I mean my recollection is that 4 everything I know, I know from Kevin Gates, and that may 5 have happened at the meeting, but I remember coming away 6 from the meeting not having learned much from Alan. 7 BY MR. OWENS: 8 Q When did you first learn about these correlated 9 trades, these matched trades from Kevin Gates? 10 A I don't know when the first time is. I know 11 that it is between the meeting and when we learned of the 12 FERC investigation. 13 Q So in other words it was prior to you learning 14 about the FERC investigation? 15 A I believe so, yes. 16 Q Do you remember in what context Kevin told but 17 these matched trades? 18 A So to me it was we never saw Alan's trades, so 19 it was all speculation on what he was doing, that is my 20 understanding of how Kevin comes up with what Alan was 21 doing. So in what context, I mean wouldn't it make -- it 22 is probably just a one off meeting in the hallway. 23 Q So face to face you didn't discuss that? 24 A Yeah. 25 Q Did he express any concern about these trades, 74 1 it seems like an unusual thing to come up in the hallway? 2 A No, our knowledge of the UTC trade evolved over 3 time. In the beginning the UTC trade us to was we didn't 4 know, we didn't understand with about the transmission loss 5 or the Transmission Loss Credit, and our understanding was 6 that you bet on congestion. It was only later that we 7 learned of the transmission component of the trade. 8 So as time went on we learned more and more. 9 For example, when we first learned about the TLC, you know, 10 it was after we started trading the UTC that we learned of 11 it, and I believe it was after we learned of the TLC that 12 we learned of the possibility that you could flow power in 13 both directions. 14 Q And again, did Kevin, when he told you about 15 this, did he express concern about this type of trade? 16 A Concern about what? 17 Q About the matched pairs? 18 A No. 19 MR. McSWAIN: Concern meaning like what, the 20 legality of it? 21 BY MR. OWENS: 22 Q Yes, let's starts with legality. 23 A Never. 24 Q Did he express any concern about the wisdom of 25 it? 75 1 A He never expressed concern about the wisdom of 2 the trade, no. 3 Q Did he express concern about the wisdom of 4 anything else related to Alan's trading? 5 A He may have expressed concern about the wisdom 6 of the PJM for allowing the trade, for allowing the trades. 7 Q Can you elaborate on that, I don't understand? 8 A Well, the same, I mean it is the same concern 9 that we, you know as you pointed out earlier, that why we 10 think the PJM is going to take away the TLC, it is 11 something that you don't see very often, it is a negative 12 transaction cost, so that is not that usual. 13 BY MR. TABACKMAN: 14 Q Do you recall any conversation with Alan Chen or 15 with Kevin Gates perhaps subsequent to that June 25th 16 meeting in which the question of the independence of the 17 two legs clearing was the subject of the conversation? 18 A Can you give me an example? 19 Q Okay. You have the -- well, let me back up for 20 a second. Do you ever recall having a discussion with 21 Kevin Gates and/or Alan Chen about what the risk was in 22 these trades where you went from A to B and B to A in the 23 same volume and at the same time, where the spread nets out 24 to zero? 25 A No, I don't remember. 76 1 Q Does it refresh your recollection if I ask you 2 about the risk of one of the legs clearing as being 3 identified as the risk that was in these trades for which 4 one can get the reward? 5 A I remember hearing that terminology, one leg 6 clearing, yes. 7 Q When do you recall hearing that, what was the 8 context, if you can tell me? 9 A I don't remember. I mean I have seen it in the 10 e-mails, I can -- 11 Q Was it before or after your learning of the 12 investigation, if you can -- 13 A Before. 14 Q Before. And was Kevin Gates the source of that, 15 or the person you were having that discussion with? 16 A I believe I saw that in an e-mail. 17 Q The question of both legs clearing? 18 A Both legs clearing, yes. 19 Q Okay. And are you talking about an internal TFS 20 Powhatan Energy Fund e-mail or an e-mail from Alan that you 21 saw the discussion in? 22 A I believe it was an e-mail from Kevin to Alan. 23 Q What do you recall about that issue that was in 24 the e-mail, as best you can recollect? 25 A I remember the words both legs or legs, or leg 77 1 and clearing. 2 Q Did Kevin ever express concern to you that a 3 trade that bore no risk, or that appeared -- that might 4 appear to others to bear no risk, was one, and for which 5 you nonetheless got a substantial reward, was a trade that 6 might create problems for Powhatan, the partnership, in 7 terms of the investment? 8 A No, he -- well, no, he did not think that that 9 would create legal -- are you talking about legal problems 10 for Powhatan? 11 Q Yes. 12 A Let me put that in context. So when we see a 13 trade that is very profitable, we always think what are the 14 risks, right? You are telling me you can take my $100 and 15 give me back $200 tomorrow, I tend not to believe you, 16 because I think you are lying, or you are taking some risks 17 that you are not telling me; right? So that is the mindset 18 is someone who would question that trade. It is not that I 19 don't think it is legal, but I think it is not true. 20 Q Did you think that Alan wasn't being truthful 21 about what the risks of the trades were? 22 A No, no, we never thought that he was misleading 23 us about what the trades were, but we always assumed that 24 people don't know what risks that they are taking. 25 Q And did you recall being a participant in a 78 1 discussion or learning of a discussion where Alan was asked 2 to identify that risk so that perhaps to just assure 3 somebody that he knew of what the risk was, and that he was 4 dealing with it? 5 A I don't remember that discussion. 6 Q Do you remember hearing about such a discussion? 7 A I don't. 8 Q Did Kevin Gates ever suggest, tell, that you 9 this was something that he felt he needed to have Alan 10 explain to him, to ensure perhaps, that Alan understood 11 what the risks were of his trade and how he was going to 12 deal with it? 13 A Can you rephrase that question? 14 Q Sure. Did you ever have a conversation with 15 Kevin Gates in which he said words to the effect of, that 16 he needed to talk to Alan and have Alan identify what the 17 risks were of these trades and perhaps even how he intended 18 to deal with the risk potential to ensure that there wasn't 19 a large loss as a result of the trades? 20 A I remember in general there was many times when 21 Kevin would ask about what are the risks in different 22 trades. This particular one I don't remember anything 23 special. 24 Q You said that you are always suspicious when 25 someone says I can take $100 and give you back $200. Have 79 1 you either back in the summer of 2010 or since, looked at 2 how much of the profitability of the trades that Alan was 3 doing in the summer of 2010 for Powhatan came from the TLC, 4 either both in terms of the percentage or the overall 5 dollar magnitude? 6 A I personally? 7 Q Yes. 8 A I have not. 9 Q Have you heard conversations about what that 10 magnitude is? 11 A My understanding is that that constitutes most 12 of our profits, that I would have heard from Kevin. 13 Q Did you ever hear that they not only, that the 14 Transmission Loss Credits not only made up for the netting 15 out of zero and whatever other, what other transaction 16 costs you might have, but created a very substantial 17 profit? 18 A I don't know the numbers exactly, they are what 19 they are, I can't argue with them. 20 Q But you didn't have a conversation about that 21 that you can recall? 22 A I don't remember. 23 Q Were you present for the, to the best of your 24 belief, the entirety of the meeting between Kevin and Alan 25 on that day, on June 25th? 80 1 A I think so. 2 BY MR. OWENS: 3 Q To the best of your recollection was Kevin 4 present for the whole meeting? 5 A That is hard for me to say. I don't remember. 6 BY MR. TABACKMAN: 7 Q I take it from what you have testified to before 8 that you don't learn much when you talk to Alan, but you 9 came away dissatisfied from the meeting with whatever it is 10 that you were talking about? 11 A That is right. 12 Q And just so we are clear, can you describe the, 13 if you can, the subject matter of the meeting and what you 14 came, why it was that you were dissatisfied, what were you 15 hoping to get and what didn't you get that left you 16 dissatisfied? 17 A That is a hard question to answer. I remember 18 him talking about nodes and PJM, you know, inside PJM, 19 outside PJM, like that is how you flow power. I don't know 20 what I was hoping to hear from him, but I -- it is hard for 21 me to answer. I don't know what I was hoping to hear from 22 him but something maybe more insightful or something more 23 maybe based on numbers. I just, I didn't get a lot out of 24 that meeting. 25 Q Was the meeting, was there any relationship, as 81 1 far as you know, between the meeting and the previous large 2 loss that Powhatan had suffered? Was Alan called in in 3 effect to have a conversation about what are we going to do 4 to avoid this happening again, and I am paraphrasing but 5 he -- or characterizing? 6 A Was I aware there was relationship between the 7 loss and the meeting? 8 Q Yes, was there a relationship as far as you know 9 between the loss and this meeting, was this something that, 10 Alan, we need to talk to you about, in effect, because we 11 have suffered this large loss and we are not happy about 12 that? 13 A I don't know. That is why we called the 14 meeting. So the way it worked is Kevin called the meeting 15 and said, Chao, do you want to go to this meeting? So I 16 just go, you know, I am not involved in planning the 17 meeting and -- I mean, you understand Kevin is the one that 18 manages Alan, you know. I spend maybe one hour a month on 19 power, I don't know what the exact amount is, but that is 20 why I don't remember a lot of these things that you put in 21 front of me because I am working in other jobs. 22 Q That is fair, and I don't mean to suggest that 23 you are not in any way being other than absolutely candid 24 in that last question. Do you recall having any discussion 25 with Kevin prior to the meeting about what Kevin hoped to 82 1 get out of the meeting? I mean why, you had -- let me 2 preface that. 3 You had had a long experience with Alan by this 4 point, a couple years. There had been this TLC thing that 5 came in, but was there -- what is it now that he needed to 6 talk to Alan about on his trades that he wanted you to be 7 there for, and created the feeling of dissatisfaction? So 8 I am wondering if there was a conversation you had with 9 Kevin before the meeting that might, that says, gee, I want 10 to try and press Alan on this point or learn more about 11 this other point, whatever those might be, anything like 12 that? 13 A I remember the impetus for the meeting may be 14 that we are ramping up with him, that we are thinking about 15 putting more money with him, maybe that is why we called 16 the meeting. And as to what Kevin wanted to learn from the 17 meeting, I don't know, and I don't think he knew. 18 He, you know, we go into a meeting, we don't 19 know what we are going to learn, we just try to learn as 20 much as we can, knowing that they are not going to tell you 21 anything, they are going to try not to tell you anything 22 new. 23 Q But you didn't work out a strategy to say I want 24 to ask him this and you press him on that, or anything like 25 that before the meeting, there is no conversation that you 83 1 recall with Kevin before the meeting along the lines that I 2 am describing? 3 A I don't remember strategizing about what do ask 4 Alan. 5 Q Thank you. 6 BY MR. OWENS: 7 Q Were you surprised that Kevin asked to you 8 participate in this meeting? 9 A No. 10 Q But it sounds as if you had very little, aside 11 from the previous summer and being somebody who is included 12 in the NDA, it sounds as if you had very little work on the 13 power side? 14 A This is true. 15 Q So why was it not surprising that Kevin would 16 pull you in? 17 A Why was I not surprised that he pulled me in? I 18 am his partner. 19 Q But he didn't pull Rich in, our Larry? 20 A That is right. 21 Q So why you? 22 A Why do I think he pulled me in and not Rich and 23 Larry? 24 Q Yes. 25 A I think he values my opinion on the technical 84 1 aspects of the trading more than he thinks Rich and Larry 2 can provide. He considers me to be more technical, I 3 believe. 4 Q Did he ever have hard data, technical data to 5 give you about Alan's trading? 6 A He may have shown me P&L's, numbers, yes. 7 Q Do you recall ever crunching data, you say one 8 of your jobs is data crunching, do you ever recall 9 crunching data on Alan's trades? 10 A No, I am pretty sure I never did. 11 Q Around this time, late June of 2010, do you 12 recall Kevin speaking with some other traders who do Up To 13 Congestion trading? 14 A Yes. 15 Q What do you recall about those discussions? 16 A Kevin brought in three people who traded for 17 some company, I don't know if it was a utility or a fund. 18 Our goal was to interview them, ask them what they can tell 19 us about their trading, and maybe hire them to work for TFS 20 to trade electricity, or hire them to work for Powhatan. 21 Q I would like to give the witness Exhibit 232. 22 (Chao Chen Exhibit 232 identified.) 23 BY MR. OWENS: 24 Q For the record, Exhibit 232 is Bates labeled 25 POW1963, and it is an e-mail from Kevin Gates to Chao Chen 85 1 with copy to Rich Gates, Eric Newman and Larry Eiben, dated 2 June 25th, 2010. 3 A Okay. 4 Q Is this consonant with your memory of him 5 bringing in the traders? 6 A Yes. 7 Q And do you recall if they came in on July 7th? 8 A I don't know the exact date, but they did come 9 in. 10 Q Are you familiar with Connective? 11 A I am not familiar. I know they trade energy, 12 that is the only thing I know, probably. 13 Q Would you give to the witness Exhibit 231. 14 Sorry to go backwards. 15 (Chao Chen Exhibit 231 identified.) 16 BY MR. OWENS: 17 Q Exhibit 231 for the record is Bates labled 18 POW2027, it is an e-mail from Chao Chen to Kevin Gates 19 dated June 22nd, 2010. 20 A I see it. 21 Q Am I correct in understanding this is in 22 reference to the same group of traders who are coming in in 23 July? 24 A Bob is the trader that came in, yes. 25 Q Bob Steele? 86 1 A Yes. 2 Q You start -- this e-mail was sent to you by 3 Kevin -- well, originally by Kevin Gates on June 22nd at 4 10:00 p.m., and Kevin writes to you, or at least I assume 5 it is to you, because the address isn't complete. Check 6 this out, I don't want to mention this to Alan when he is 7 in WC later this week, though. I assume WC means West 8 Chester? 9 A Yes. 10 Q Did you, did either of you ever mention these 11 other traders to Alan Chen? 12 A No, I don't think I did. 13 Q Now, you respond what appears to be four minutes 14 later, we got too much shit going on. What do you mean by 15 that? 16 A We are too distracted with things outside of TFS 17 mutual funds, TFS Market Neutral. 18 Q Is one of the distractions Powhatan? 19 A That is what I meant, yes. 20 Q In the last paragraph of your e-mail you say, we 21 should sell TFS and concentrate on power; what do you mean 22 by that? 23 A That is somewhat of a joke. TFS at this point 24 in 2010 I believe had about $2 billion in assets, and we 25 have maybe one million in power, so it is just a reference 87 1 to something that, you know, earlier when we first learned 2 of power we thought that could be a business for TFS, that 3 we could run it ourselves instead of as opposed to hiring 4 outside managers, and paying them to trade and not knowing 5 what they trade, that was one of the options. So it just a 6 reference to that, sort of in a joking way. 7 Q So power at this point was pretty small potatoes 8 to TFS? 9 A Yes. 10 Q The next sentence you write $5 million on 500k 11 VAR is misleading though. You can lose 500k a day for 10 12 days straight. What does that mean? 13 A In power you are required to put up very little 14 collateral in order to make trades. So, for example, in 15 equities, if I want to buy a million dollars of equities I 16 have to show up with pretty much a million dollars of cash. 17 In power you can take on a lot of risk without 18 putting down a lot of collateral, so they will let you make 19 bets bigger than you are allowed to make in the equities 20 world. 21 So in power we have this issue that you we 22 cannot measure performance as a percentage of assets or 23 percentage of collateral because it is misleading, because 24 in equities you have to put up a lot of capital, and so if 25 you make $1 on $100 it looks like one percent. 88 1 But in power if you want to make the same size 2 bet you don't have to put up $100, you can put up $1, so it 3 looks like you made 100 percent, but the risks are the 4 same. You know, in equities you could lose that $1, you 5 only lost one percent, but here you could lose that $1 and 6 you lost 100 percent, and when that happens you have to 7 pony up more money. So your real asset is more than what 8 is posted as collateral. 9 Q Hand the witness Exhibit 234. 10 (Chao Chen Exhibit 234 identified.) 11 BY MR. OWENS: 12 Q For the record, Exhibit 234 is Bates labeled 13 POW2438, and it is an e-mail from Kevin Gates to Chao Chen 14 and Rich Gates, with a copy to Kevin Gates, Larry Eiben and 15 Eric Newman, dated June 25th, 2010. 16 A Okay. 17 Q This e-mail, if you bounce back to page POW2439 18 you will see that it starts with Kevin's e-mail of 19 2:25 p.m. on the 25th, writing to you, and that if memory 20 serves, is the same as Exhibit 232 that you have already 21 received. 22 MR. McSWAIN: You are saying that the Exhibit 23 you want to talk about chronologically is similar to a 24 previous exhibit. 25 BY MR. OWENS: 89 1 Q Yes, the e-mail you see of 2439 is, that copy, 2 that e-mail from Kevin Gates at 12:25 p.m. is exhibit, that 3 is Exhibit 232. Do you see? 4 A Okay, I see that. 5 Q And then you see a response from Eric Newman 6 about -- well, let me step back for a second, 2:25 p.m. on 7 the 25th, the 25th is the day you are meeting with Alan 8 Chen; is that correct? 9 A You mean 12:25 p.m.? 10 Q Yes, stepping back to Kevin Gates first, the 11 e-mail he sends on 25th of June at 12:25 p.m. The 25th of 12 June, that is the day you are meeting with Alan Chen; is 13 that correct? 14 A I don't remember, but I think you know better 15 than me. 16 Q You said that that meeting with Alan began 17 around 11:00 because of the power outage? 18 A That is my guess. 19 Q Was, to the best of your knowledge was it over 20 by 12:25? 21 A I have no idea. 22 Q Was it a long meeting, a short meeting? 23 A It was a short meeting, as I recall. 24 Q So Alan flew all the way to Houston to meet you 25 guys for just a little over an hour? 90 1 A I remember it was a short meeting, and I 2 remember that because of the power outage. In fact that 3 morning I was not in the office, and I am not sure about 4 the 11:00 time, because -- I think there are some e-mails 5 because before that we were doing the previous day's trade 6 allocation. We had to do that in Rich Gates' house because 7 our office didn't have power. So it was the three of 8 influences Rich's house trying frantically to get it in 9 under some deadline, and whenever that e-mail went out 10 would be a little bit before when the meeting started. 11 Q The three of you meaning Kevin Gates, Rich Gates 12 and you? 13 A No, Rich and I and another employee, Ron, 14 Maralit. M-a-r-a-l-i-t. Sorry, M-a-r-g-a-l-i-t. 15 Q What does Ron do? 16 A He does technology, and he is a computer 17 programmer. 18 Q And how does that relate to your trades of that 19 morning? 20 A So every evening, every afternoon, we stop 21 trading at 4:00, and between 4:00 and about 7:00 we have to 22 send out the trades that we made that day in the hedge fund 23 and the mutual fund, we have to send those trades out to 24 our brokers and to, you know, several counterparties. 25 And because the previous evening the power was 91 1 out, we couldn't do that, and so the next day we had to 2 recover the trades and send them. And that is kind of a 3 technical thing because of the systems not being automated, 4 so once the automation doesn't run, then you have to 5 remember how to do it by hand, and that took a long time. 6 Q I see. I see. So about 2 1/2 hours after Kevin 7 sends this e-mail, if you look higher up on the chain at 8 2439, Eric Newman writes that the numbers or the story 9 sounds great: Guys who know how to make a lot of money but 10 work for a big company but couldn't keep most of it, and 11 the numbers look great, too. Then he continues, I think it 12 would be useful to get a sense of the correlation of their 13 trading to Alan's. Either just looking at correlation of 14 returns, or see if they are generally trading at the same 15 nodes/contracts on the same day. 16 What -- well, first of all, do you recall 17 receiving Eric's e-mail? 18 A I don't. 19 Q Were you concerned about the correlation of 20 these traders, their strategies with Alan's? 21 A This looks like a typical e-mail from Eric. He 22 sends a lot of e-mails with correlations. So that is, you 23 know, everyone kind of has their thing. 24 Q What does he mean when he uses the word 25 correlation? 92 1 A Well, we validate a lot of -- in the equities 2 world we evaluate a lot of strategies, so you prefer 3 strategies to be less correlated or not correlated or 4 almost negatively correlated to each other. So, if you 5 have two strategies and they both make 10 percent a year 6 with the same kind of volatility, you want them to be less 7 correlated. If they were perfectly correlated they would 8 be the same strategy, but if they were negatively 9 correlated then by combining them you can make better risk 10 adjusted returns. 11 Q So this is a reference to diversification? 12 A Yes. 13 Q The cyclical and countercyclical? 14 A Same idea, yes. 15 Q Let's go up to the next e-mail in the sequence, 16 Rich Gates writes at 3:54 p.m., Numbers look great... but 17 wonder if they backed out the fees? What does that mean, 18 wonder if they backed out the fees? 19 A In investment there is return before fees and 20 return after fees. So, for example, in the mutual fund we 21 charge 2 1/2 percent fees. So, if somebody gives us money 22 we put that into stocks and we buy and sell. At the end of 23 the year $100 turns into $110. So 10 percent is the before 24 fee performance, and 7 1/2 is after fees performance. So 25 looking at that, I believe what Rich is asking is the 93 1 numbers they gave us, did that include the fees or not? 2 Q Rich's next sentence states, I would prefer not 3 to participate in the meeting if the discussion will center 4 around the intricacies of their trading since I do not 5 think it makes sense to get me up to speed on it. 6 So to your understanding, Rich was not 7 particularly involved in the understanding the power 8 markets? 9 A That is right. 10 Q He was focused elsewhere? 11 A He was focused on the mutual funds like I was. 12 Q So TFS, the people who were most focused on 13 power would be Kevin, first and foremost, and then you and 14 Kevin Byrnes? 15 A Kevin first, me second and -- Kevin Byrnes is 16 not focused, he went to one dinner, he has nothing to do 17 with power. So Kevin Gates, myself, Rich would be third, 18 but it drops off very quickly. 19 Q Then you look at the next e-mail in the chain, 20 an e-mail from you to Rich, copying Kevin, Larry and Eric, 21 at almost 9:00 in the evening, and you write, I just read 22 the presentation, I am not that excited about it. I think 23 UTC is just a loophole that anyone who knows about it can 24 exploit. There is very little skill. I wouldn't hire any 25 of these guys to work for TFS, including Alan. 94 1 What -- why weren't you excited about it? 2 A I thought it wasn't interesting, I thought I 3 wasn't learning anything from what they were presenting. 4 Q And this is a reference to Bob Steel's 5 presentation which I can hand up to you if you would like? 6 A Yes. 7 Q But do you recall receiving or do you know that 8 was attached to Kevin's e-mail? 9 A I must have read it, I don't remember what is in 10 there, but I, you know, none of these guys tell you 11 anything anyway, yeah. 12 Q That sentence, I think UTC is just a loophole 13 that anyone who knows about it can exploit. There is very 14 little skill. A loophole; what do you mean? 15 A I meant it was so -- I didn't know exactly what 16 Alan was doing and how he was making the money, and I 17 didn't know how Bob was making the money. So I assumed 18 that they were doing the same thing to make money. 19 Q Let me stop you, just a quick question, by the 20 same thing are you referring to using the TLC's? 21 A At this point I don't think I had much of an 22 appreciation for the TLC. It is a very general feeling 23 that I had, that it was something either new or didn't 24 know, and if you knew, it was very easy for you to make 25 money in UTC. And is that an answer you are looking for? 95 1 Q Off the record. 2 (Discussion off the record.) 3 BY MR. OWENS: 4 Q Back on the record. If I understand your last 5 answer, you -- were you or -- well, let me ask you this. 6 Were you or were you not referring to the TLC when you say 7 I think UTC is just a loophole? 8 A I don't think I was. 9 Q So you were referring to all Up To Congestion 10 trades? 11 A The UTC trading, the UTC market in general, I 12 was saying that it appears to not be a well designed market 13 because it seems that it requires very little skill to make 14 money. 15 Q If it required very little skill to make money 16 wouldn't you want to invest a lot more money in it, I mean 17 wouldn't you want to invest unlimited amounts of money in 18 it to take these profits? 19 A Sure. 20 Q Did you have any concern that a type of trade 21 trading that is a loophole would have, would face problems 22 down the road if PJM discovered this loophole? 23 A I didn't have any concerns that it is an illegal 24 activity, I think that is what you are getting at. So when 25 I said loophole it is something that is allowed under the 96 1 rules, but it is not, you know, a properly designed set of 2 rules. 3 Q Earlier today you noted that there was some 4 concern that, about retroactive changes in the rules, that 5 is to say PJM would change the rules retroactively and take 6 away the TLC, is that consonant with the notion that UTC is 7 a loophole? 8 A Let me think about your question. 9 Q Take your time. 10 A The concern have anything to do with the fact I 11 think it is a loophole? 12 Q Yes. 13 A I guess they are related. The concern was that 14 UTC would retroactively change the rules. So, they 15 realized that there was a loophole, the concern was they 16 would retroactively try to close the loophole. 17 Q So when you said it is a loophole, you also 18 mentioned it was a market inefficiency? 19 A Poorly designed market. 20 Q Poorly designed market, thank you. So is it 21 fair to say you thought this was a mistake by PJM? 22 A No, I don't know if it is a mistake or 23 intentional. 24 Q But you are concerned that it is a loophole and 25 it is a poorly designed market and once PJM got up to speed 97 1 on it, it would close that loophole and potentially 2 retroactively claw back the credits? 3 A Yeah. I mean the reason we talk a lot about 4 this retroactive. I think there was -- the reason we were 5 concerned about that is because there was a case where PJM 6 did retroactively assess charges on all members, so, there 7 was an example of PJM doing that. That is why that was one 8 of the possibilities we thought could happen. 9 Q But this is, I mean it sounds as if this is 10 some, that this is a -- as much more of a mistake that PJM 11 made in designing the market, so your concern is that once 12 they discover this error, they are going to correct it? 13 MR. McSWAIN: I don't think what is he said, if 14 you are trying to characterize his testimony. Are you 15 asking him a new question about that? 16 BY MR. OWENS: 17 Q I am not trying to characterize testimony, I am 18 just making sure I understand it. 19 A So I don't know why PJM designed their market 20 that way, maybe it is intentional, maybe it is a mistake, I 21 don't know what it is. 22 BY MR. TABACKMAN: 23 Q Did I hear you say that in terms, in referring 24 to something in PJM or UTC trades as a loophole, you 25 weren't referring specifically to the TLC's? 98 1 A That is right. 2 Q Then what was it about the UTC trade that made 3 you feel that it was a poorly designed market, if it wasn't 4 the fact that there were these TLC that could generate lots 5 of profit, other than -- 6 A The reason -- sorry. 7 Q -- other than through the trades; what was it 8 that made you feel it was a loophole and poorly designed? 9 A The reason I wrote that is because my 10 understanding of the UTC is that it is similar to the 11 inc/dec market, yet people prefer the UTC over the inc/dec. 12 So I knew that there were some differences that made people 13 want to do this, right? I now could achieve similar things 14 in both, and so I didn't appreciate the distinction between 15 UTC and inc/decs, but I knew that it is cheaper basically 16 trading the UTC. 17 Q And that made you feel that it must be 18 inefficient or poorly designed? I am just try to 19 understand, I am not trying to characterize it. I just 20 want to make sure I understand what it was that made you 21 conclude it was poorly designed and a loophole that any 22 dummy could exploit? 23 A Because I, my understanding was that UTC is -- 24 they are basically the same thing as inc/decs, but somehow 25 better. 99 1 (4:57 p.m. -- recess -- 5:23 p.m.) 2 BY MR. OWENS: 3 Q Mr. Chen, look back at Exhibit 234, at the last 4 e-mail in sequence. Kevin responds to you, looks like 20 5 minutes, about 20 minutes after you wrote, and he states, I 6 agree that UTC is a loophole that probably a dummy can 7 exploit. But, why rule these guys off? Just because they 8 are doing UTC? They should drive a truck through that 9 loophole, even if they know how that FTR's/ICE or Virtuals. 10 That is what I would do. Do you recall receiving that last 11 e-mail in sequence? 12 A I don't remember it without seeing this, but I 13 accept that I received it. 14 Q Did you have any other conversations with Kevin 15 about UTC being a loophole or something of that nature? 16 A Yeah, I don't remember it specifically, but that 17 is how we understood the UTC to be, and I know the word 18 loophole means different things to different people. That 19 is just how we talk about loopholes and the way we see it, 20 you know. Loophole just means an anomaly, something that 21 nature shouldn't allow, but it is, you know, we spent a lot 22 of time saying loopholes, I just don't want to give the 23 impression that we think it is something bad or to be 24 hidden. This is all very public, you know, that is how we 25 speak to each other, and sure, we think UTC as an 100 1 opportunity, you know. 2 Maybe that is another more politically correct 3 way to say it, but that is how we, you know, we thought UTC 4 was an opportunity that may go away soon because it is such 5 a nice opportunity. I don't know that there are specific 6 instances where we talked about that, but that was our 7 general feeling about it. 8 Q Okay. When you met with Bob Steele's group in 9 early July 2010, do you, did you talk about the UTC trade? 10 A I don't remember exactly what we talked about at 11 the meeting, but we would have talked about their trading, 12 we would have tried to find out what they did and how they 13 made money. 14 Q Did you mention to Bob that you were working 15 with Alan Chen? 16 A No. 17 Q How long did this meeting last? 18 A I am guessing two hours, I don't remember. 19 Q And who was there? 20 A I don't remember. If I had to guess I would say 21 myself and Kevin, but I don't remember. 22 Q Did you meet at your offices in West Chester? 23 A We have a conference room. 24 Q Do you recall Bob's group doing a presentation 25 of some kind? 101 1 A Yes, I remember there was a PowerPoint. I am 2 not positive, but I remember that. 3 Q Was this in the nature of a pitch, basically? 4 A Yes. 5 Q What was your impression of their pitch? 6 A Well, just what I wrote here. I mean, I guess I 7 wrote in before the meeting. 8 Q It looks like a couple weeks before the meeting? 9 A I don't remember. What was my impression, well, 10 what do I remember from the meeting? Again, I am sorry, I 11 don't remember very much from the meeting. I don't 12 remember thinking these guys are great. I just -- I don't 13 remember. I don't have a strong recollection of the 14 meeting. 15 Q But you know you didn't mention Alan Chen to 16 them? 17 A Yeah, I wouldn't have. I mean I can't say 100 18 percent I didn't mention Alan Chen, but I don't think I 19 would have. 20 Q Why not? 21 A You try not to say unnecessary, tried not to 22 give unnecessary information. 23 Q Did Alan impress you more than Bob's group? 24 A I don't think so. 25 Q Did you and Kevin have a postmortem, talk about 102 1 the meeting? 2 A I don't remember, but I would guess that we 3 would have, yeah. 4 Q Do you recall if Kevin had any particular 5 reaction to Bob's presentation? 6 A I don't remember. 7 Q Do you recall if Bob's presentation, and his 8 discussion of UCT and UTC strategies, did that resemble 9 Alan Chen's strategies as you understood it at that time? 10 A I don't remember him saying anything specific at 11 all about the strategies. I remember there were three 12 guys, I don't remember if all three of them were there, but 13 I think it was Bob and maybe one other guy. 14 I know there were three of them, I forget if all 15 three were there or if two or one were there, but I know 16 Bob was there. The only things I remember from the meeting 17 was that one of the guys had a horse farm in Maryland. 18 Like we talked about things like that, like what is your 19 situation, and what would it take, you know, for you to 20 come work here, what do you need, that kind of subjects 21 rather than the strategy. 22 Q Did TLC's come up? 23 A I don't remember. 24 Q Did you ask them to educate you on what UTC 25 trading was, that is to say, did you come into it as if you 103 1 were completely new to UTC trading, or were you looking for 2 or asking them for more of an intermediate level of course? 3 A I don't remember. 4 Q I will show to the witness Exhibit 238. 5 (Chao Chen Exhibit 238 identified.) 6 BY MR. OWENS: 7 Q For the record, Exhibit 238 is Bates stamped 8 POW1849, an e-mail from Kevin Gates to Kevin Byrnes, copies 9 to Rich Gates, Eric Newman, Chao Chen, Yan Liu and Larry 10 Eiben on July 26, 2010. 11 A All right. 12 Q Do you recall receiving this e-mail? 13 A I don't recall, but I think it is true that I 14 received it. 15 Q Do you notice the first e-mail in sequence, that 16 it to say the first in time, was sent by Kevin Byrnes. Is 17 this the Kevin Byrnes you had described earlier today? 18 A Yes. 19 Q So he is the new employee who had interned at 20 Constellation? 21 A Yes. 22 Q If you look at the second paragraph of Kevin's 23 e-mail which is on page POW1850, he writes, "I tried to 24 find out what kind of trades Rob put on," parens, I think 25 Rob is, appears to be his friend at Connective, from 104 1 context, "specifically since I overheard the other day that 2 most people coming in seem to know only one type of 3 strategy paren (UTC?) Question mark, close paren, to see if 4 maybe everyone was just aping that trade. But all my 5 friend could tell me was that he did quote 'mostly gas 6 futures and some energy,'" close quote. 7 Do you recall discussing with Kevin any of his 8 discussions with friends at other trading outfits? 9 A Yes, I have discussed with Kevin about 10 electricity trading. 11 Q During the summer of 2010? 12 A Yes. 13 Q What did he tell you that his other friends who 14 were power trading were doing? 15 A He didn't tell me what they were doing. I don't 16 think he knew what they were doing. 17 Q What did you discuss with him? 18 A He talked about the friend he has at Connective, 19 he knew that we were trading energy and he wanted to help 20 us either recruit people or do research. 21 Q And it sounds like Kevin knows what UTC trading 22 is, at least on a general level? 23 A I don't know what Kevin knows. I don't remember 24 talking to him about any specifics of UTC, I may have. I 25 mean, I may have said the word UTC to him. 105 1 Q Is it possible UTC trading came up at dinner 2 with Alan Chen about a month earlier? 3 A It is possible, but I don't remember. 4 Q Now, if you look at the last e-mail in sequence, 5 Kevin Gates' e-mail, in which he copies you and others, it 6 says, he has four numbered paragraphs, paragraph number 2, 7 Our interviews from last week were consistent with this. 8 None of them were rockstars, and they almost certainly 9 wouldn't get a job offer if they didn't know the UTC trade. 10 Is Kevin's characterization of Bob's group -- 11 first of all, I am assuming this is a reference to Bob's 12 group? 13 A I believe so. 14 Q Thank you. And is his characterization of Bob's 15 group consistent with your understanding of Kevin's take 16 away? 17 A Yes. 18 Q So the only -- am I to understand that the only 19 reason they would possibly get a job offer is because of 20 the UTC trade? 21 A That is what Kevin says here. 22 Q Was that your take away as well? 23 A Was that my take away of Kevin's opinion? 24 Q Was that your opinion as well, that is an 25 opinion you shared? 106 1 A I agree they were not rockstars, and the rest I 2 don't know if I agree with. 3 Q Paragraph 3 reads, Of course, please keep it 4 strictly confidential when talking with others that we're 5 engaging in the quote "UTC" unquote trade. Really, just 6 knowing about this inefficiency is really our only edge. 7 How to you understand that to mean? 8 A Well, so Kevin wrote that and, you know, I don't 9 know what he was thinking at that time, but when I read 10 that, when we trade we like to have some kind of an edge. 11 So, for example, in equities we like to think that we are 12 better than other people in finding hidden statistical 13 anomalies, so that makes us feel like well, maybe this will 14 persist, that we can spend time and energy and money and 15 develop a strategy and program the computers and make it 16 implement this algorithm and it will have a payoff. 17 So that was nice for us to have an edge, so when 18 we look at a strategy we like to think, why do we expect to 19 make money here? And my interpretation of that sentence is 20 we don't have much of an edge here other than we know 21 about, the knowledge that this exists like, just like these 22 other traders know about UTC. 23 Q This inefficiency, he describes the UTC trade as 24 an inefficiency, is that along the lines of this loophole 25 that we discussed a few minutes ago in some other e-mails? 107 1 A What did he mean that the inefficiency is a 2 loophole? 3 Q Yes, that the UTC -- well, here he appears to be 4 saying UTC trade is an inefficiency. And earlier you and 5 he had both had an e-mail exchange described the UTC as a 6 loophole? 7 A Yes. 8 Q So am I correct in understanding this is 9 referring to the loophole? 10 A My take from the phrasing is that it means the 11 same thing, that -- that is right. 12 Q What is a quant? 13 A A quant is a shorthand for quantitative analyst 14 or quantitative trader, someone who uses computers or 15 algorithm statistics to make trading decisions. 16 Q That sounds a lot like your style of trading? 17 A That is right. 18 Q I will show the witness Exhibit 243. 19 (Chao Chen Exhibit 243 identified.) 20 BY MR. OWENS: 21 Q For the record, Exhibit 243 is Bates-stamped 22 POW4041. It is an e-mail from Kevin Gates to Rich Gates, 23 Eric Newman, Chao Chen and Larry Eiben, on August 2nd, 24 2010. 25 A Okay, I read it. 108 1 Q Will you look at the second e-mail in sequence 2 from Alan Chen to Kevin Gates on August 2nd at 1:04 p.m., 3 Alan writes to Kevin, Just wanted to let know that I got a 4 call from Dr. Bowring of PJM Monitoring Analytics this 5 morning about the large volume trades we put on. I have 6 promised him that I will not put on those trades starting 7 tomorrow. 8 And then Kevin writes back, appears to be eight 9 minutes later, and -- well, doesn't write back, excuse me. 10 He forwards it to you and your team. FYI I am guessing 11 that Alan was up about $3 million last month. We keep 12 80 percent of that. The exact number will be posted later 13 this week. 14 Month to date, I estimate that he is up 15 $250,000, parens (his estimate below is understated, I 16 think) close paren. But his note below doesn't bode well 17 for the longevity of this degree of profitability. So 18 please make sure to enjoy it now, while you can. 19 Do you recall receiving this e-mail? 20 A Somewhat. 21 Q What do you mean somewhat? 22 A Kind of. I mean I read it last week, and before 23 that I don't know if I could have remembered. 24 Q Do you know who Dr. Bowring is? 25 A I believe he worked for Monitoring Analytics, 109 1 which is a contractor for PJM. 2 Q Had you heard his name before this e-mail? 3 A No. 4 Q Let's start with the top of the e-mail with 5 Kevin's note as he forwards this to you. I am guessing 6 that Alan was up $3 million last month, and that you will 7 keep 80 percent of that. That seems like a very large 8 number? 9 A That is a large number. 10 Q Is this level of profitability something that 11 surprised you? 12 A I wasn't surprised, I was happy about it. 13 Q And I believe this is, this was sent on 14 August 2nd, and Alan is already up $250,000 for the month, 15 that seems pretty impressive? 16 A It is a lot of money. 17 Q When Kevin says, writes that Alan's notes 18 doesn't bode well for the longevity of this degree of 19 profitability; what did that mean? 20 A What did Kevin mean when he wrote that? 21 Q What do you understand he meant? 22 A So if I had to interpret that it would mean to 23 me that we may not be able to make this kind of profit 24 forever. 25 Q Were you surprised to learn that this Dr. 110 1 Bowring had called Alan expressing concerns about the 2 trades? 3 A I don't remember being surprised. 4 Q Were you -- previously you mentioned that you 5 had described this UTC trading as a loophole, as an 6 inefficiency. Does this flow that shutting this down, this 7 trade down, does this flow with your previous expectations? 8 A This is consistent with the previous 9 expectations. 10 Q So for a while you had believed that this type 11 of trade was not long for this world? 12 A We thought it might end. 13 Q Did you have any discussions with Kevin about, 14 around this time about the Alan shutting down the trade? 15 A I think so. I think we discussed this event. 16 Q What did -- outside of this e-mail, what did 17 Kevin tell you? 18 A I don't remember, but this is -- I mean I 19 remember that someone from PJM noticed Alan and told him to 20 stop trading. 21 Q Is that something you wanted Alan to do, stop 22 this trading after Dr. Bowring had called him? 23 A Yes, we wanted to do whatever PJM asked him to 24 do. 25 Q You hadn't heard of a change in the rules yet, 111 1 this is just the Market Monitor dialing up and complaining 2 to Alan? 3 A I have not. At this point I don't remember 4 hearing that PJM changed the rules. 5 BY MR. TABACKMAN: 6 Q Were you aware at or about the time that Alan 7 was making these trades of the volumes of megawatts that he 8 was trading? 9 A Can I go back to the previous question? 10 Q Sure. 11 A At that time I thought PJM was Dr. Bowring. I 12 didn't realize that Dr. Bowring was not PJM. I thought PJM 13 told Alan to stop trading. 14 BY MR. OWENS: 15 Q But you also said you hadn't heard of Dr. 16 Bowring before this time? 17 A That is right, before today or before -- 18 Q Before this e-mail? 19 A Yes, before this e-mail I didn't hear of him. 20 BY MR. TABACKMAN: 21 Q Are you saying that you interpreted the e-mail 22 that now that Dr. Bowring called you thought that meant PJM 23 had called? 24 A Yes, when I read the e-mail I didn't pick up on 25 Dr. Bowring, I just thought that PJM to Alan to stop 112 1 trading. 2 Q To go back to the other question, were you aware 3 at or about the time of the trades that Alan was making of 4 the volume that he was trading on an hourly or daily basis? 5 A No. 6 Q Do you recall at earlier times expressing some 7 annoyance that prior to the conclusion of these trades in 8 August, about Alan's continuing to say inconsistent things 9 about the effect of volume on the profitability of the 10 trades? 11 A Yes. 12 Q And subsequent, have you since looked at the 13 volumes that he was trading in June and July? 14 A I don't remember ever looking at the exact 15 numbers, so again, everything kind of goes through Kevin. 16 So like I said before, you know, when you asked about 17 Eric's e-mail, he talks about correlation was correlation. 18 The correlation is Eric saying, he talks about correlation 19 all the time and I tend to ask about capacity and moving 20 the market. 21 Q And were you aware, do you know how Alan was 22 able to avoid the negative effects of volume that he had 23 talked about that seemed to have plagued him earlier on his 24 trading in June and July? 25 A No. 113 1 Q Thank you. 2 A Okay. And I don't know that there was adverse 3 effects of volume, but in equities trading it is a rule 4 that, rule of thumb that if you trade more you get worse 5 prices, so I was applying that same idea to -- 6 Q And there were some e-mails, too, I think, where 7 had expressed your concern. Alan had said at one point 8 this was scaleable and then next, maybe a week or two later 9 or a month later he said, gee, I got caught up, the trade 10 went bad because of volume, we lost money because of 11 volume, and yet he clearly was not, he was quite successful 12 in July, and making $3 million on volumes that were large 13 enough for the Market Monitor to call him and ask him to 14 stop, and I was wondering if you knew how he was able to 15 accomplish that? 16 A I didn't make that connection. 17 Q Okay. 18 BY MR. OWENS: 19 Q I would like to publish to the witness 20 Exhibit 244. 21 (Chao Chen Exhibit 244 identified.) 22 BY MR. OWENS: 23 Q For the record, Exhibit 244 is Bates-stamped 24 POW4065. It is an e-mail from Kevin Gates to Rich Gates, 25 Eric Newman, Larry Eiben, Chao Chen, Fredrick Mike, Sam 114 1 Harris and Greg Sekelsky on August 6, 2010. 2 A Okay, I have read it. 3 Q I want to point you specifically to -- well, 4 there are three numbered paragraphs in Kevin's e-mail. 5 Paragraph No. 2 Kevin writes, There is reason to believe 6 that our days are limited with this fund, as there is 7 pending regulatory changes that may eliminate Alan's trade. 8 This would be a huge disappointment. 9 Is this in reference to PJM shutting down the 10 TLC trades? 11 A My interpretation of that is that this is -- 12 this is consistent with the fact that PJM told Alan to stop 13 trading such large a volume of UTC's. 14 Q So to use a words used in a previous e-mail, 15 this was effectively closing the loophole that, is that 16 fair to say? 17 A Are you asking is Kevin saying that this will 18 close the loophole? 19 Q Well, in a few weeks, a few months earlier you 20 had referred to UTC trades as a loophole, and Kevin had 21 agreed with you and said, loophole that any dummy can 22 exploit. And subsequently Kevin referred to the UTC trade 23 as an inefficiency, that that is really your edge, that is 24 to say, knowing about it was your edge. Now Kevin is 25 saying that there is pending regulatory changes that may 115 1 eliminate Alan's trades. 2 So that is, this loophole that you talked about 3 earlier, this is what appears to be happening here, is the 4 loophole is being closed; is that correct? 5 A So my understanding is UTC is changing the 6 rules -- PJM is changing the rules of the UTC trades such 7 that it won't be as profitable as before. 8 Q Exactly so. That is closing this loophole that 9 you had talked about six weeks earlier? 10 A Yeah, I -- okay, I know what you are trying to 11 get me to say the word loophole. The inefficiency is 12 ending, the loophole is closing, yes. 13 Q And this, as you said with the previous exhibit, 14 this at this point wasn't really a surprise, you had had 15 some anticipation that this was likely to happen at some 16 point in time? 17 A It was reasonable to expect this, yes. 18 BY MR. TABACKMAN: 19 Q Can I ask a question? Was it your understanding 20 that the UTC trade was being shut down or the Transmission 21 Loss Credits were being potentially ended, the regulatory 22 change that Kevin is referring to, when it says it may 23 eliminate Alan's trades; did you understand that there was 24 no longer going to be Up To Congestion trades? 25 A All I thought was things were changing, and I 116 1 had no idea how exactly they were changing. I didn't try 2 to guess. 3 Q I see. By the way no one is trying to get you 4 to say anything, we are asking questions, just trying to 5 figure out what the connections are between various things 6 that people write. 7 Let me ask you this: You were aware that long 8 before transmission -- PJM began giving Transmission Loss 9 Credits to traders, Alan Chen was making money doing UTC 10 transactions; is that correct? 11 A That is what I was believe, that he was making 12 money before. 13 Q He was just making a whole lot more money when 14 there were Transmission Loss Credits? 15 A That is what I understood. 16 Q But the Transmission Loss Credits were not the 17 loophole and the inefficiency that is being referred to in 18 this these documents, when you talk that UTC is just, or 19 that the trade is just a loophole? 20 A I am not saying that TLC is not involved in the 21 UTC being a loophole. I am just saying what I thought of 22 Alan's trading, it wasn't like I knew so clearly how it 23 broke down and exactly how he made the money. So for me I 24 am at the level where I thought it was trading as UTC 25 versus inc/dec trading, and I didn't drill down to 117 1 understand exactly what is the inefficiency. 2 BY MR. OWENS: 3 Q I would like to publish to the witness Exhibit 4 246. 5 (Chao Chen Exhibit 246 identified.) 6 BY MR. OWENS: 7 Q For the record, Exhibit 246 is Bates-stamped 8 POW2368, and the last e-mail in sequence is an e-mail from 9 Alan Chen to Kevin Gates with a copy to Larry Eiben and 10 Chao Chen, dated August 19, 2010. 11 A Okay, I have read it. 12 Q If you look at the first e-mail in sequence, 13 e-mail from Kevin Gates to Alan Chen with a copy to you and 14 Larry Eiben, in the last paragraph of that e-mail Kevin 15 writes, Finally, what are your thoughts going forward? I 16 think that it makes sense to hold-off from doing UTC trades 17 until we get more clarity on the issues raised by FERC. 18 Had you had a discussion with Kevin around this 19 time about issues being raised by FERC on the UTC trades? 20 A I remember that FERC sent us a letter from the 21 Office of the Enforcement. I don't know if that is what 22 you are talking about, but it could be. 23 Q And did you have a conversation with him 24 regarding asking Alan to hold off on further UTC trades? 25 A I don't remember talking about that 118 1 specifically. 2 (Chao Chen Exhibit 247 identified.) 3 BY MR. OWENS: 4 Q For the record, Exhibit 247 is Bates-stamped 5 POW6665, an e-mail from Kevin Gates to Larry Eiben, Chao 6 Chen and Rich Gates, sent on August 19, 2010. 7 A Okay. 8 Q In this e-mail Kevin forwards to you and Larry 9 and Rich something he received from Alan on the 19th of 10 August, and in his narrative Kevin writes, FYI here is a 11 filing that PJM recently did with the FERC regarding 12 changing the rules to close the loophole that Alan was 13 exploiting. I will read it tonight. You can too, if you 14 are bored. 15 So changing the rules to close the loophole that 16 Alan was exploiting, that is consonant with what you have 17 been discussing this afternoon, the loophole that you 18 identified at this point two months earlier that, but now 19 more specifically it looks like we are referring to the TLC 20 funds? 21 A Where does it say that? 22 Q I will grant you it doesn't specifically state 23 that TLC funds down in the body. This is also largely a 24 link to a PJM document. Were you aware that the FERC 25 filing had been concerned with or had mentioned anything 119 1 about the TLC's? 2 A I don't remember what the FERC complaint was 3 about specifically, I knew it was about Alan's trading, and 4 it was about market manipulation. What was the logic, I 5 don't know, or I don't even know now. 6 MR. McSWAIN: You might be getting mixed up. He 7 is asking with -- are you asking about an attachment to 8 this e-mail, which I guess we don't have attached to it. 9 MR. OWENS: Well, there is -- 10 MR. McSWAIN: He is not talking about like the 11 investigation, he is asking about the attachment to this 12 e-mail generally, that you have. 13 THE WITNESS: Okay. Then I don't remember, I 14 don't think I clicked on the link. 15 BY MR. OWENS: 16 Q Well, if you look down to the narrative at the 17 bottom of 6665, in the small type, I will point you to, 18 well, the first line you can see PJM submitted for filing 19 revisions. And if you locate the verb beyond that, you 20 will go down to the end of the third line, to eliminate 21 market participants' ability to improperly submit Up To 22 Congestion bids the sole purpose for which is to obtain an 23 allocation of the marginal revenue surplus. Are you 24 familiar with marginal loss revenue surplus? 25 A No. 120 1 Q Or marginal loss surplus allocation; have you 2 heard that term before? 3 A I might have heard it. 4 Q MLSA? 5 A It looks familiar. I don't know what it means. 6 Q Would it surprise you that that is a synonym for 7 TLC's? 8 A No. 9 Q If it a synonym for TLC's, Kevin's reference 10 above it, would that -- when he refers to the changing the 11 rules to close the loophole that Alan was exploiting, does 12 that connect, that concept more directly to the marginal 13 loss revenue surplus? 14 A I am not sure I understand the question. You 15 are saying are they connected? 16 Q That is to say, the loophole that Kevin 17 describes above, the loophole that Alan was exploiting. 18 Looking below the discussion here from PJM's filing is to 19 eliminate market participants' ability to improperly obtain 20 allocation of the TLC's. So the TLC's in fact are the 21 loophole that Kevin is talking about? 22 MR. McSWAIN: Are you asking for his 23 interpretation of what Kevin was thinking? 24 BY MR. OWENS: 25 Q Yes, his understanding at the time? 121 1 MR. McSWAIN: If you had an understanding at the 2 time. 3 THE WITNESS: My understanding was that the UTC 4 trades that Alan was doing, which I did not know what he 5 was doing, was not being allowed by the PJM, and that was a 6 change from before. I know it is about the UTC and part of 7 that trade. 8 BY MR. OWENS: 9 Q So it wasn't your understanding that PJM was 10 proposing to eliminate all UTC trades? 11 A I don't know if they were or not. 12 BY MR. TABACKMAN: 13 Q Today do you interpret, looking at this document 14 today, do you interpret Kevin's reference to closing the 15 loophole to be a reference to what is described in the 16 paragraph at the bottom of the page 6665? 17 Kevin says in his paragraph, let me be clear, 18 Kevin says, here is a filing that PJM recently did with the 19 FERC regarding changing the rules to close the loophole 20 that Alan was exploiting, and I am asking you if you read 21 that today to be saying to close the loophole that Alan was 22 exploiting he is referring to the paragraph that summarizes 23 the FERC filing at the bottom of page 6665? 24 A When I read that I do think that he is referring 25 to that paragraph. 122 1 Q Thank you. 2 BY MR. OWENS: 3 Q Did -- when was the last time you had 4 communication with Bob Steele? 5 A I have no idea. 6 Q Do you recall whether you had any communication 7 with him after your interviews in July? 8 A I don't remember, but it is possible. 9 Q Do you recall -- 10 A I am sorry, after our interview? We, I think we 11 did, I don't know if personally I did, but we would have 12 followed up. 13 Q Do you recall Kevin ever speaking to you about, 14 well, first let me give you a timeframe so we can have more 15 clarity. Around the time of these FERC filings, PJM 16 talking to you and shutting down the trade, do you recall 17 Kevin ever mentioning a conversation or communication he 18 had with Bob Steele? 19 A Yes, I remember after the FERC changed the 20 rules, I remember Kevin said he talked to Bob about the 21 change. 22 Q Do you recall any of the specifics of that 23 conversation? 24 A Give me a moment, I need to try to recall what 25 was said. One thing I remember was Kevin said that Bob 123 1 said that they knew that other people were doing this UTC 2 trade. 3 Q Did Kevin mention if Bob had ever engaged in the 4 TLC trade? 5 A It was my understanding that Bob collected the 6 TLC, or his trading was motivated by TLC, but I don't 7 remember -- I don't remember if Kevin told me that or Bob 8 told me that. That was my impression. 9 Q I will pose to the witness Exhibit 248. 10 (Chao Chen Exhibit 248 identified.) 11 BY MR. OWENS: 12 Q For the record, Exhibit 248 is Bates-stamped 13 POW1879, an e-mail from Kevin Gates to Robert Steele on 14 Friday, August 20th, 2010. 15 Bob is a little wordy in here so take your time 16 to review it. 17 A Okay. 18 Q Now, I understand you are not copied, at least 19 publicly copied on this e-mail. Do you recall whether you 20 were either bcc'd or whether a copy of any of these e-mails 21 was ever forwarded to you? 22 A I don't remember seeing this e-mail but I mean I 23 just -- I remember this information, this is not the first 24 time I have read this. Or I mean I don't know the exact 25 wording, but the idea about he knew about Alan's trading, 124 1 Steele knew about Alan or I don't know if he knew him by 2 name, but he knew people that were doing this trading. 3 Q If you look at, go to the first e-mail in 4 sequence on page 1880. Kevin wrote to Bob at 3:48 p.m. on 5 August 19, Hi, Bob, at your convenience could you please 6 give me a call? 7 And then if you look at Bob's, Bob writes back 8 the next morning, and in his opening paragraph in material 9 part he says, I wanted to get back to you with the 10 information we outlined on the phone yesterday. Below is a 11 general outline of some of the things we discussed. Please 12 feel -- excuse me, feel free to call if you have any 13 further questions. 14 So you mentioned a few moments ago that you 15 recall Kevin saying to you that he had had a conversation 16 with Bob. Does this refresh your recollection about what 17 time you may have heard Kevin tell you about this 18 conversation? 19 A Yes. 20 Q Were you, did you participate in this phone call 21 between Bob and Kevin? 22 A I don't remember. 23 Q Did Kevin give you a report, in some fashion of 24 what he and Bob talked about? 25 A I think so. The information here sounds like 125 1 something I knew. 2 Q I want to point you, there are three numbered 3 paragraphs in Bob's e-mail, by paragraphs I mean actual 4 paragraphs here instead of the usual reference to a single 5 line or two. 6 In paragraph 2 Bob writes, In the PJM committee 7 proceedings last week, the membership voted in favor of 8 PJM's proposal to eliminate the quote "gaming" practices 9 going on in the UTC market. 10 If we bounce down a few more lines, sentence 11 beginning this action: This action will close the loophole 12 that allowed a few participants in question to quote "game" 13 unquote, the no risk arb between the cost of non-firm 14 transmission paren (0.67) close paren, and the 15 reimbursement for marginal losses on certain trades, parens 16 (about $1.80) close parens. Is this something that Kevin 17 told you about? 18 A Was that the PJM is changing the rules as such? 19 Q More specifically about gaming the, Bob's 20 characterization of this as gaming the no risk arbitration? 21 A What is the question? 22 Q Did Kevin express to you that Bob thought that 23 this type of trading was gaming the no risk arbitration, 24 arbitrage, pardon? 25 A I don't remember Kevin telling me that Bob 126 1 thought in was gaming. 2 Q In the third paragraph, it is a very long 3 paragraph, Bob writes, How did all this get started? The 4 following outline is my understanding, not necessarily 5 absolute truth. One market participant parens (perhaps 6 Mr. Chen) close parens, figured out the quotes (free arb) 7 unquotes, via the transmission loophole. Most participants 8 (myself and Connective included) close parens, perceived 9 this as rank manipulation of the intended market function 10 and had enough sense not to participate in this 11 activity...don't kill the goose that laid the golden egg. 12 Do you recall Kevin expressing to you, or I 13 should say, informing you that Bob interpreted this 14 activity as rank manipulation of the intended market 15 function? 16 A I remember seeing this paragraph, I don't know 17 where, but I remember seeing this with my own eyes before. 18 Q Does that characterization, Bob's 19 characterization; does that concern you? 20 A Does that concern me right now or did it concern 21 me before? 22 Q Let's starts with before. 23 A I don't remember being concerned. 24 Q Does it concern you today? 25 A It concerns me in what way? Like that is a very 127 1 general question. It doesn't concern me that -- it doesn't 2 make me think that the activity you are describing is rank 3 manipulation, but it concerns me that it makes you think 4 that it is manipulation. 5 Q Does it concern you that an experienced trader 6 in the UTC market elected to characterize it as rank 7 manipulation? 8 A I mean, again, it concerns me that -- it is an 9 opinion on the FERC's side. 10 BY MR. TABACKMAN: 11 Q Let me ask you this: Did Kevin ever say to you 12 that he thought that Bob Steele was just, my expression, 13 blowing a lot of smoke when he wrote this, didn't know, you 14 know, just was trying to pat himself on the back? Did 15 Kevin ever express that to you of this exchange with Bob 16 Steele to you? 17 A I don't remember Kevin, I don't remember what 18 Kevin said about this exchange, but the way I read it, he 19 is trying to make himself come off as, hey, hire me, don't 20 hire this other guy, hire me because I am a top tier 21 trader. I am not going to engage in these questionable 22 processes, so that is how I read it now. 23 Q Would it surprise you to learn by this point 24 Mr. Steele had already engaged in a relationship with a 25 different entity, he wasn't looking for a position anymore 128 1 with TFS? 2 A I don't remember what his employment situation 3 was. 4 BY MR. OWENS: 5 Q If you look a little further down the paragraph, 6 This got the attention of PJM and the market monitor and 7 they started to investigate, finally realizing the 8 magnitude of what was going on parens ($19 million out of 9 their pockets to these few quote "rogue" unquote traders) 10 close parens. Did Kevin ever tell you that Bob thought 11 that the kinds of trades that Alan Chen engaged in was 12 rogue, that someone like Alan Chen would be a rogue trader? 13 A Again, I believe I read this text before so I 14 can read that that is what he wrote. 15 Q Did you have any discussion with Kevin or anyone 16 else at the time about the prospect of Alan being 17 considered a rogue trader? 18 A We have never considered Alan a rogue trader, 19 based on what we know. So I don't remember being concerned 20 about that. 21 Q The next sentence reads, the other two entities 22 that stepped in to take advantage of the situation are 23 Energy Endeavors and City Power Marketing. Have you ever 24 heard of either of those companies? 25 A No. 129 1 Q Have you ever heard of somebody named Steven 2 Tsingas, T-s-i-n-g-a-s? 3 A I don't remember. Who is he? 4 Q I am asking you. 5 A Okay, I don't remember. 6 Q Have you ever heard of anyone named Kim Jurco, 7 J-u-r-c-o? 8 A I don't remember. If I had more contact I might 9 remember. 10 Q Do you know of a company called Coal Train 11 Energy? 12 A I don't remember. 13 Q Peter Jones? 14 A I don't remember. 15 Q Sean Shehan? 16 A I don't remember. 17 BY MR. TABACKMAN: 18 Q When you say you don't remember, just so we 19 understand what you mean by I don't remember, none of those 20 names ring a bell that you have ever heard of them before; 21 is that right. 22 A That is right. 23 MR. TABACKMAN: Thank you. 24 BY MR. OWENS: 25 Q Bouncing back to paragraph 2, but on the top of 130 1 1880, the first full sentence reads, The other hidden 2 benefits of this action is that quote (copy-cat) unquote 3 trading will be eliminated. Since the purchase of 4 transmission is a public record, some market participants 5 would monitor the key traders and attempt to mimic their 6 trading strategies. With the elimination of the 7 transmission leg of the UTC transaction, this transparency 8 will be gone. All-in-all, I feel this rule change should 9 be beneficial for us top tier traders in the UTC market. 10 Setting aside his patting himself on the back, 11 were you familiar with the fact that traders could, there 12 was a certain amount of transparency in this trading system 13 and that traders could follow each other's strategies? 14 A I didn't know that. 15 Q So no one, Alan had never told you about this? 16 A I don't remember him telling me that. I didn't 17 know that until now. 18 BY MR. TABACKMAN: 19 Q Had you ever heard that the Oasis reservations 20 were public in the sense that if you were a participant in 21 the market you could see who was reserving how much 22 megawattage on what paths? 23 A That sounds familiar, but I had no appreciation 24 of that. 25 MR. OWENS: That is all for me. 131 1 MR. McSWAIN: I don't have any questions. 2 MR. OWENS: Mr. Chen, thank you so much. I 3 appreciate your time. 4 THE WITNESS: You are welcome. 5 (Whereupon, at 6:22 p.m., the deposition was 6 concluded.) 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 132 1 C O N T E N T S 2 WITNESS EXAMINATION 3 CHAO CHEN, Ph.D. 4 By Mr. Owens 3 5 6 7 8 9 10 E X H I B I T S 11 EXHIBIT NUMBER IDENTIFIED 12 Chao Chen Exhibit 203 22 13 Chao Chen Exhibit 202 23 14 Chao Chen Exhibit 204 25 15 Chao Chen Exhibit 208 27 16 Chao Chen Exhibit 210 29 17 Chao Chen Exhibit 250 33 18 Chao Chen Exhibit 213 36 19 Chao Chen Exhibit 216 40 20 Chao Chen Exhibit 219 42 21 Chao Chen Exhibit 221 47 22 Chao Chen Exhibit 222 47 23 Chao Chen Exhibit 251 57 24 Chao Chen Exhibit 230 65 25 -- continued -- 133 1 E X H I B I T S (Continued) 2 EXHIBIT NUMBER IDENTIFIED 3 Chao Chen Exhibit 232 84 4 Chao Chen Exhibit 231 85 5 Chao Chen Exhibit 234 88 6 Chao Chen Exhibit 238 103 7 Chao Chen Exhibit 243 107 8 Chao Chen Exhibit 244 113 9 Chao Chen Exhibit 246 117 10 Chao Chen Exhibit 247 118 11 Chao Chen Exhibit 248 123 12 13 14 15 16 17 18 19 20 21 22 23 24 25