The four traders in question, who boasted in emails and instant messages about how "fun" it was to "crap on" certain physical power prices, did not actually carry out the complex scheme they are accused of by the Federal Energy Regulatory Commission, a source familiar with the bank's thinking said.

Last week, the country's top cop overseeing electricity markets ordered Barclays to demonstrate why it should not pay a $435 million civil penalty, plus $34.9 million in the repayment of ill-gotten gains, for manipulation of California power markets between 2006 and 2008.

The British banking giant, still reeling from an nearly equivalent fine over its role in rigging the Libor interest rate benchmark, has already said it will "vigorously" fight the FERC charges, likely setting up a landmark court battle.

It believes electricity trades on the days of the traders' messages show their West Coast trading team was not intentionally manipulating prices for profit, despite the "unfortunate" emails released in FERC's 73-page regulatory filing, the source said.

Any losses incurred on the bank's mammoth trades -- which on some days accounted for more than half of all the deals in specific markets -- was an effort to "build credibility" with potential clients in a new market.

In fact, on more than half of the days in question, the bank actually made money or lost very little, the source said, an outcome seemingly at odds with FERC's accusation that it was engaged in so-called "uneconomic trading", where losses in one market would yield larger profits in another.

To prevail in its case, which stems from an investigation that began in July 2007 after an anonymous tip-off from other market participants, FERC will have to demonstrate the traders' messages demonstrate "intent" to manipulate markets - a tough, though not impossible hurdle to meet, legal experts said.

FERC spokesperson Mary O'Driscoll declined comment, citing the agency's policy of not commenting on open cases.

INTENT AND DISREGARD

Typically, in a manipulation case FERC must show the accused individuals or companies knew or acted with "reckless disregard" toward good business practices in their industry, said Susan J. Court, former chief of enforcement at FERC.

"To prove that that's the answer is difficult," she said, "because it goes to the intent" of the traders' actions. "So sometimes it comes down to interpreting those electronic messages and what they mean in context."

Barclays will argue that even taking into account the emails the traders did not act on the messages.

Examining emails alone, "you could argue that it's a manifestation of intent. But if you look at the real trading, it just doesn't line up," the source said.

Across 35 alleged months of alleged manipulation, the traders were either making money or "losing hardly anything" during more than half the days, according to the source.

All four of the traders accused in the case - Daniel Brin, Scott Connelly, Karen Levine, and Ryan Smith, who also have 30 days to "show cause" on penalties amounting to $18 million - have left Barclays since the alleged manipulation.

Their legal status is unclear; Brin declined comment when reached on his mobile phone by Reuters last week. Efforts to reach the other traders were unsuccessful.

Since Congress enhanced FERC's enforcement powers in 2005, the commission has only concluded a finding of manipulative intent in one case: Brian Hunter, the former natural gas futures trader whose massive bets sank hedge fund Amaranth in 2006. Key to the finding were Hunter's instant message communications, in which he asked fellow traders to take actions that would benefit his bets that natural gas futures would tumble.

The commission fined Hunter $30 million in April 2011, an amount "appropriate and sufficient" to discourage others from engaging in market manipulation, FERC said at the time.

The case is now on appeal.

HIGH STAKES

The stakes in the Barclays case are significantly higher than the sums involved, for both sides of the docket.

Though Barclays quit the energy trading business in the Western United States almost a year ago, it is still reeling from $450 million in penalties over the Libor interest rate rigging that cost former CEO Robert Diamond his job. FERC's enforcement action could potentially double those fines and the negative publicity the bank has experienced in recent months.

For FERC, the case could underscore the agency's determination to go after manipulation - a cause championed by enforcement chief Norman C. Bay.

Of 12 investigations opened by FERC's enforcement staff during the year ended September 30, 2011, eight involved market manipulation or false statements to the agency, according to the most recent data, including against banking giant Deutsche Bank's energy trading arm and BP.

Bay may be emboldened by the record $135 million fine, plus $110 million in return of ill-gotten profits he won in a settlement with Constellation Energy Group Inc earlier this year. However, some in the industry argue that the FERC had leverage in that case -- power provider Exelon Corporation's pending takeover of Constellation -- that doesn't exist with Barclays.

Marc L. Spitzer, a former FERC commissioner who worked with Bay on enforcement actions, declined to comment on the Barclays case. However, he praised Bay for his ability to judge when to pursue enforcement actions.

"Norman Bay has a good sense for which cases he should move and which cases he should settle on," Spitzer said.

Settling, however, may not be an attractive option to Barclays because the bank may not want to be seen giving any ground on a charge of manipulation, said Paul Korman, an energy attorney at Van Ness Feldman in Washington D.C.

"It is a very serious charge, so we see more and more people who are willing to fight it out," said Korman, who is not involved in the Barclays proceedings. "Historically, most of these cases settled."

Barclays' strategy suggests it is taking a different approach than London-based oil trader Arcadia, which was sued last year by the Commodity Futures Trading Commission (CFTC) for allegedly rigging physical crude markets in order to reap gains on the futures exchange. Arcadia and two traders have argued that the CFTC did not have authority to pursue physical trades.

The issue of "interconnected markets", as it is known, is a thorny one for many regulators, whose remits often cover one or the other side of the marketplace, but rarely both.

It is a more complex issue than those facing FERC and other regulators a decade ago, when the Enron scandal exposed traders who had simply inflated California's power prices or reported false trade to energy index providers.

The now-defunct energy giant's infamous market manipulation during the 2000 to 2001 California energy crisis is still fresh in many consumers' minds, raising ire from advocates who want to see FERC take even tougher sanctions against the bank.

NEXT STEPS

If Barclays does fight to the finish, the final outcome of FERC's action, as well as any fines paid, could be a few years away, experts said. Barclays must respond by the end of this month, unless an extension is granted; FERC then has 60 days to determine whether to impose the fine, which is likely.

At that point, assuming Barclays does not settle, the case would shift to one of several legal avenues.

If it goes before an administrative law judge, a hearing could take about a year, said Court, the former FERC head of enforcement. Additional time to consider the judge's finding and hold a re-hearing could take an additional three to four months each, she said, making it about two years before the case is even ready for an appeal in federal court.

Another option is for Barclays to request to try the case from scratch in federal court, an option it is "leaning toward," according to the source familiar with the matter.

Still, based on the fact that the case has even gone this far, Court places FERC's chance of prevailing at "over 50 percent."

"The staff is not going to waste the commission's time if they don't think they have a good case," she said.

(Reporting by Jonathan Leff; Editing by Marguerita Choy)

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