[Senate Hearing 107-521]
[From the U.S. Government Publishing Office]
S. Hrg. 107-521
EFFECTS OF SUBTITLE B OF S. 1766 TO THE PUBLIC UTILITY HOLDING COMPANY
ACT
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
TO EXAMINE THE EFFECTS OF SUBTITLE B OF S. 1766, AMENDMENTS TO THE
PUBLIC UTILITY HOLDING COMPANY ACT, ON ENERGY MARKETS AND ENERGY
CONSUMERS
__________
FEBRUARY 6, 2002
Printed for the use of the
Committee on Energy and Natural Resources
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii FRANK H. MURKOWSKI, Alaska
BYRON L. DORGAN, North Dakota PETE V. DOMENICI, New Mexico
BOB GRAHAM, Florida DON NICKLES, Oklahoma
RON WYDEN, Oregon LARRY E. CRAIG, Idaho
TIM JOHNSON, South Dakota BEN NIGHTHORSE CAMPBELL, Colorado
MARY L. LANDRIEU, Louisiana CRAIG THOMAS, Wyoming
EVAN BAYH, Indiana RICHARD C. SHELBY, Alabama
DIANNE FEINSTEIN, California CONRAD BURNS, Montana
CHARLES E. SCHUMER, New York JON KYL, Arizona
MARIA CANTWELL, Washington CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware GORDON SMITH, Oregon
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Brian P. Malnak, Republican Staff Director
James P. Beirne, Republican Chief Counsel
Leon Lowery, Professional Staff Member
Howard Useem, Senior Professional Staff Member
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 1
Campbell, Hon. Ben Nighthorse, U.S. Senator from Colorado........ 3
Craig, Hon. Larry E., U.S. Senator from Idaho.................... 4
Hemmingway, Roy, Chairman, Oregon Public Utility Commission,
Salem, OR...................................................... 17
Hempling, Scott, Attorney at Law, Silver Spring, MD.............. 41
Hunt, Isaac C., Jr., Commissioner, U.S. Securities and Exchange
Commission..................................................... 7
Johnson, Hon. Tim, U.S. Senator from South Dakota................ 6
Marlette, Cynthia A., General Counsel, Federal Energy Regulatory
Commission..................................................... 24
Murkowski, Hon. Frank H., U.S. Senator from Alaska............... 4
Shelby, Hon. Richard C., U.S. Senator from Alabama............... 2
Sokol, David L., Chairman and CEO, MidAmerican Energy Holdings
Company, Des Moines, IA........................................ 33
Thomas, Hon. Craig, U.S. Senator from Wyoming.................... 4
Wyden, Hon. Ron, U.S. Senator from Oregon........................ 3
APPENDIXES
Appendix I
Responses to additional questions................................ 83
Appendix II
Additional material submitted for the record..................... 91
EFFECTS OF SUBTITLE B OF S. 1766 TO THE PUBLIC UTILITY HOLDING COMPANY
ACT
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WEDNESDAY, FEBRUARY 6, 2002
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, D.C.
The committee met, pursuant to notice, at 9:32 a.m., in
room SD-366, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN,
U.S. SENATOR FROM NEW MEXICO
The Chairman. Why do we not go ahead with the hearing?
This is a hearing to examine the effects of the repeal of
the Public Utility Holding Company Act of 1935 on energy
markets and energy consumers and whether the recent events,
particularly related to the collapse of Enron, raise concerns
that there are protections that are afforded by PUHCA that need
to remain in place. And the obvious question is whether the
legislation that we are preparing to consider on the Senate
floor has adequate protections in it. Senator Daschle and I
have introduced a bill that contains a repeal of PUHCA, but
there are many issues that continue to be raised about the
adequacy of the protections against some of the abuses involved
with the Enron collapse.
It may seem unusual to people to be having a hearing on
this type of major provision in legislation so late in the
process or so soon before we actually get to consideration of a
bill on the floor, but I do think that questions that have been
raised justify us going ahead with the hearing.
The Holding Company Act clearly creates barriers to entry
into the electricity and the gas businesses. That was a purpose
of the legislation. Obviously, as we move to a market-based
industry, rather than a monopoly-based industry, the
appropriateness of maintaining those barriers has been brought
into question.
There are protections for consumers and shareholders as
well in the Public Utility Holding Company Act, and many of
those do not constitute barriers to entry. I think there is a
consensus that those should be preserved in some form, and the
question is whether we have the right form. We have provisions
in the bill that we have proposed that are intended to replace
some of the key provisions in PUHCA and to supplement existing
authority in order that we can assure that consumers are
adequately protected if PUHCA is repealed.
We want to hear from the witnesses today about the adequacy
of the provisions we have included in our proposed bill, if
there is something else that is needed before Congress proceeds
to consider repeal of PUHCA, and what the effect of all of this
will be on the structure of the electricity market in
particular, the electricity industry in particular, in the
future.
I believe, although Senator Murkowski is not here, the
prime sponsor of the bill to repeal PUHCA in the Banking
Committee, a bill which has been reported out of the Banking
Committee with a substantial vote, is here, and that is Senator
Shelby. And I was going to ask him to make any short statement
he would like before we got to the witnesses.
STATEMENT OF HON. RICHARD C. SHELBY, U.S. SENATOR
FROM ALABAMA
Senator Shelby. Thank you, Mr. Chairman.
Mr. Chairman, as you have just said, the Senator Banking
Committee reported S. 206, the Public Utility Holding Company
Act of 2001, favorably by a vote of 18 to 1.
I appreciate your calling this hearing, Mr. Chairman, and
welcome the opportunity to clarify and reinforce the need for
reform of the Public Utility Holding Company Act of 1935 that
we know as PUHCA.
If the purpose of this hearing, Mr. Chairman, is to bring
to light the problems with Enron and their business practices
and how PUHCA could have saved the day, then I think this
hearing is misguided and inappropriately timed. If, Mr.
Chairman, on the other hand, the goal is to highlight the
realities of PUHCA, in light of Enron's collapse, then I think
that we should take this opportunity to distinguish fact from
fiction just to be sure we are all working with the same
information.
It has long been my belief that PUHCA has become a barrier
to innovation and competition in the utility industry. Numerous
studies have found that the conduct that gave rise to the act
has all but disappeared, and since PUHCA's inception in 1935,
comprehensive Federal securities regulations have been
developed that, in essence, duplicate those required by the
act. At the same time, changes in the industry have brought
into question the continuing relevance of a monopoly-based
model of regulation.
Mr. Chairman, I believe the facts clearly show that Enron's
collapse had nothing to do with the Public Utility Holding
Company Act of 1935. Enron, for example, was not subject to the
registration requirements of PUHCA. The SEC had numerous
opportunities to review Enron's activities to determine whether
or not the provisions of PUHCA applied to them.
After close review and consideration of the act, the SEC
either issued no-action letters, which I would interpret to
mean the SEC did not believe Enron was engaging in activities
covered under the Public Utility Holding Company Act, or they
issued a single-State exemption, which was clearly provided for
under the law. I am pleased, Mr. Chairman, that Commissioner
Hunt is here to detail for us what PUHCA was intended to do,
under what circumstances it was intended to apply, and how it
was ultimately implemented.
For more than a decade, industry, regulators, Congress, and
consumer groups have called for repeal and/or reform of PUHCA.
I appreciate this opportunity to review PUHCA and clarify the
need for reform.
Mr. Chairman, I want to thank you for allowing me to make a
statement out of turn on this issue, and I believe this will be
a good hearing.
I have a conflict, Mr. Chairman, that requires me to leave,
but I hope you have a long and interesting hearing.
The Chairman. Thank you.
I am told that some of the other members here wanted to
make short statements. Let me just call on them, if they do.
Senator Wyden, did you wish to make any statement?
STATEMENT OF HON. RON WYDEN, U.S. SENATOR
FROM OREGON
Senator Wyden. I would and I will be very brief, Mr.
Chairman.
I am anxious to explore this issue because a coalition of
consumer groups recently has raised some very troubling
questions in a letter to our committee about how Enron avoided
regulation under PUHCA. These groups asserted that if Enron had
been regulated as a holding company under the act, the collapse
of Enron might have been avoided.
Whether one supports or opposes PUHCA, the law is still on
the books. It is Congress' job, not that of the regulators, to
decide whether it ought to be repealed or not. So, I want to
see how it was that Enron was able to fly under the regulatory
radar screen. I think we need to examine whether there was
proper enforcement of the law, whether there was a adequate
review when Enron self-certified that it qualified for
exemption under PUHCA.
So, there are a number of questions I want to ask the
witnesses about this, and I appreciate your holding this
hearing so promptly, Mr. Chairman.
The Chairman. Very good. Senator Campbell, did you wish to
make a short statement?
STATEMENT OF HON. BEN NIGHTHORSE CAMPBELL,
U.S. SENATOR FROM COLORADO
Senator Campbell. Very short, Mr. Chairman. Thank you for
holding this hearing.
Repeating, PUHCA has been discussed and criticized for
several years, and I think we have done six or eight hearings
in this committee on it. In fact, many PUHCA critics argue that
the 66-year-old act amounts to an outdated, burdensome, and
duplicative set of regulations. They believe that existing
State regulation over retail sales, Federal oversight of
wholesale transmission, and existing antitrust regulations
provide sufficient security for the ratepayers. Others strongly
argue that PUHCA should not be repealed. They believe that the
Public Utility Holding Company Act is the only regulation that
effectively prohibits companies from risky investments and
under-capitalization that could hurt ratepayers.
I, like many of the members of this committee, tend to
support limited government involvement because I think all
parties can act more efficiently without too much government
involvement. But surely the government's oversight should be
streamlined as much as possible.
I am also concerned that streamlining government oversight
to some degree might harm consumers. This year, of course, the
Enron debacle has added a new twist to our hearings that we did
last year, but I like Senator Shelby think we should probably
not focus on whether to repeal PUHCA solely in terms of the
Enron situation.
It is well documented that Enron was an exempted company
because it was a trading company, owning only one utility in
Oregon. Some might argue that if Enron was not exempted from
PUHCA, then sufficient government oversight would have
prevented the company's collapse. I think that is not only
highly unlikely, but I think that this line of argument takes
us away from the central focus of whether PUHCA should be
repealed because it has outdated its usefulness.
In any event, I am looking forward to the hearing and I
appreciate your calling it. Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Thomas, did you have any statement you wish to
make?
STATEMENT OF HON. CRAIG THOMAS, U.S. SENATOR
FROM WYOMING
Senator Thomas. Thank you, Mr. Chairman. I just agree with
the Senator that hopefully this is not an Enron hearing. I hope
it is on PUHCA. That is what we are talking about.
The Chairman. Let me ask. Senator Craig, did you have any
statement you wish to make?
STATEMENT OF HON. LARRY E. CRAIG, U.S. SENATOR
FROM IDAHO
Senator Craig. I wish to associate myself with the remarks
of the Senators from both Alabama and Colorado. Let us have the
hearing. Let us talk PUHCA.
The Chairman. Senator Hagel, did you have any statement?
Senator Hagel. I have never heard of Enron, Mr. Chairman.
[Laughter.]
Senator Hagel. I look forward to hearing the witnesses.
Thank you.
The Chairman. Senator Murkowski, did you have a statement
you wish to make?
STATEMENT OF HON. FRANK H. MURKOWSKI, U.S. SENATOR
FROM ALASKA
Senator Murkowski. Thank you, Senator Bingaman. I
appreciate the opportunity to address this subject once again.
We have had this before the committee for an extended period of
time. This topic began long before my chairmanship, and
hopefully under your chairmanship, we can dispose of it.
I think it is fair to recognize that PUHCA was created in
1935 to address abuses associated with power generation. Since
that time, we have had a number of layers of regulatory
oversight that I feel address the concerns that we have in the
oversight responsibility of the committee.
I noted when I came in the reference to Enron. I think I
would echo that the cause of Enron's demise was primarily due
to bad business judgment, bad accounting practices, fundamental
lack of honesty and control within the management. It was not
because there were not enough regulations. PUHCA, specifically,
had absolutely nothing to do with these matters. With or
without PUHCA, Enron would have gone bankrupt. I do not think
there is any question about that. Crooks rob banks because that
is where the money is, and even though there are laws against
it, it still occurs.
Now, I think it is curious that we are having a debate on
the eve of the Senate taking up a comprehensive energy bill, in
which we believe PUHCA reform should be included. It has been
around a long time, as I have said. It is well understood. This
committee held extensive hearings in the 104th, 105th, 106th,
and early on in the 107th Congress on electricity and the
implications of PUHCA repeal.
Incidentally, PUHCA repeal has been reported out by the
Banking Committee four times since 1995. There is joint
referral, with the Banking Committee on that issue. In fact, it
is the Banking Committee's jurisdiction.
PUHCA repeal in the Daschle bill, which is pending, is word
for word, from the Banking Committee's reported bill, which was
reported out by a bipartisan vote of 19 to 1. The Banking
Committee fully understands the issue. It was not willing to
create a super-PUHCA at FERC to replace an antiquated PUHCA at
the SEC.
Had our committee held a business meeting, I venture that
we would have agreed with the Banking Committee. But that was
not allowed to happen. As a consequence, Senator Bingaman and I
have had a discussion about this. I indicated I was for PUHCA
reform. He feels that it is necessary to have this hearing to
examine it even further. The consequences of Enron as a
probable cause of this I can only reflect on with some
conjecture.
In any event, I would hope that this hearing today does not
stop the momentum on PUHCA reform. I have supported PUHCA
repeal on its merits. It is supported by the Bush
administration. It is a key part of their national energy plan.
PUHCA repeal was also reported by the Clinton administration,
the Clinton administration. It was a key part of their
electricity legislation.
PUHCA repeal is both pro-competitive and pro-consumer.
PUHCA repeal does not eliminate consumer protections. It was
President Clinton's Securities and Exchange Commission that
recommended repeal of PUHCA. That recommendation was endorsed
by President Clinton and his FERC.
To meet consumer demands, we must get rid of the
regulations that prevent companies from responding to changing
market conditions. We have seen changing market conditions over
the last year in power generation. To meet consumer needs, we
have to get rid of those unnecessary regulations. I feel that
participants in the electric power industry are deterred from
taking competitive actions out of fear of becoming tangled up
with PUHCA.
How does this prevent companies from competing in the sense
of benefitting consumers? Some assert that PUHCA repeal will
allow consumers to be harmed. I find that false, and I would
hope that somebody might be able to enlighten me this morning.
FERC will retain authority and responsibility for wholesale
electric rates. Wholesale rates can go up only if allowed by
FERC. States retain authority and responsibility for retail
electric rates. Retail rates can go up only if allowed by State
regulatory authorities. What is wrong with that? PUHCA repeal
does not diminish these authorities. There is no so-called
regulatory gap created by PUHCA repeal. Moreover, the Banking
Committee language guarantees Federal and State regulators
access to utility books and records necessary to protect
consumers.
In addition, nothing in this language prevents other
regulatory agencies from protecting consumers, whether it be
the Federal Trade Commission, the U.S. Department of Justice,
and the State antitrust.
I have had these three principles for good electric
legislation, which has been coined by professional staff. One,
we must deregulate where we can. Two, we must streamline where
we cannot deregulate. Three, we must not stand in the way of
States' efforts to address local concerns and needs. I think
PUHCA repeal advances all of these three principles.
My position is clear. I will not support any electricity
title that does not include PUHCA repeal. In addition, I will
not support any electricity title that replaces PUHCA with more
draconian regulations.
Finally, PUHCA is 66 years old. It was designed to cure the
problems of a long-gone, depression-era industry structure.
It is time to retire PUHCA.
The Chairman. Senator Johnson, did you have any opening
statement?
Senator Johnson. Mr. Chairman, I have a statement, but I am
going to simply submit it for the record. And I look forward to
the testimony of the panel.
The Chairman. Okay.
[The prepared statement of Senator Johnson follows:]
Prepared Statement of Hon. Tim Johnson, U.S. Senator
From South Dakota
Mr. Chairman, this is an important and timely hearing on PUHCA. The
Enron situation has brought new attention to PUHCA, its effectiveness,
and whether it is still needed in a competitive energy environment.
For years, PUHCA has been attacked as a law that is outdated for
today's more competitive environment, and that it is a relic of
Depression-era laws. In response, there have been continuous attempts
to repeal PUHCA. I have always believed that this must be approached
cautiously. Today's energy world is not a truly competitive
environment. There is competition on the wholesale market but very
little competition in the retail market. In addition, some states have
enacted electricity restructuring, but others have not, leaving a
unevenness to the competition in the field. I have always been
concerned about undue concentration and believe that we must have
enough safeguards to ensure that sustainable, competitive markets are
in place.
As you all know, S. 1766 includes provisions to repeal PUHCA but
also included provisions that would strengthen merger review,
strengthen FERC's ability to review market-based rates, and increase
market transparency. At the time of the bill's introduction in
December, there appeared to be a fair amount of consensus that this was
a good approach to take if PUHCA was to be repealed.
However, the Enron collapse has resulted in another review of PUHCA
repeal and has raised new questions. As an exempt holding company, some
of PUHCA's stricter rules would not have applied to Enron. On the other
hand, perhaps if PUHCA was not in place, Enron would have expanded its
utility business far beyond what it did, causing even greater havoc on
customers and employees.
We must look at this issue very carefully before decisions are made
because there are substantive arguments on both sides of this issue.
Protecting consumers is of paramount importance and we must consider
whether PUHCA continues to play an important role there. We must also
must consider whether PUHCA's presence is creating more barriers than
are necessary to enter electricity markets. We also must consider
whether additional safeguards are needed either on the state and/or
federal level to ensure that the activities of electricity utilities
and entities are properly reviewed.
Mr. Chairman, there is not much time before the Senate is due to
consider the energy legislation but holding this hearing is an
important opportunity to hear the viewpoints of those concerned. There
are strong views on both sides on this issue and the only way to move
forward is to find some consensus. Ultimately, the needs of energy
consumers are the most important factor in this debate. The only way to
protect consumers is to determine the most rational solution. It is
clear that this is your goal and I pledge to work with you and the rest
of the Senate in the coming weeks to help achieve consensus that helps
our consumers.
The Chairman. We have five very distinguished witnesses
here. Let me introduce them all and then we will just call on
them in the order that I introduce them and give them each
about 10 minutes. If they could try to summarize their main
points, they do not need to take 10 minutes, but they have got
that long if they want to.
First, the Honorable Isaac C. Hunt, Jr., who is a
Commissioner with the Securities and Exchange Commission, is
here to speak on behalf of the Securities and Exchange
Commission.
Next is the Honorable Roy Hemmingway, who is Chairman of
the Oregon Public Utility Commission, in Salem, Oregon.
Next, Ms. Cynthia Marlette, who is the General Counsel for
the Federal Energy Regulatory Commission.
Mr. David Sokol, who is the chairman and CEO of MidAmerican
Energy Holdings Company in Des Moines, Iowa.
And Mr. Scott Hempling, who is an attorney at law in Silver
Spring, Maryland.
We appreciate their being here. Why do we not just proceed
in that order? Mr. Hunt, why do you not begin and we would be
anxious to hear your point of view.
STATEMENT OF ISAAC C. HUNT, JR., COMMISSIONER,
U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Hunt. Thank you. Good morning, Chairman Bingaman,
ranking member Murkowski, and members of the committee. I am
Commissioner Isaac Hunt of the U.S. Securities and Exchange
Commission.
I am pleased to have this opportunity to testify before you
on behalf of the SEC regarding the provisions in title II of S.
1766, the Energy Policy Act of 2002, which would repeal much of
the Public Utility Holding Company Act of 1935.
As you know, for almost 20 years, the SEC has consistently
supported repeal of those provisions of PUHCA that either
duplicate laws administered by other regulators or that are no
longer necessary. Since I last testified on PUHCA repeal in
December, the magnitude of the Enron debacle and the harm that
Enron's collapse has tragically inflicted on the company's
investors and employees has become clearer. Congress and
various regulatory agencies, including the SEC, are
appropriately investigating what happened at Enron, why it
happened, and what should be done to prevent Enron-like
debacles in the future.
As we continue to investigate and learn from the events
surrounding that collapse, we remain open-minded and, of
course, would reconsider our views on conditional PUHCA repeal
if warranted. Currently, however, we are not aware of anything
that would cause us to conclude that there is reason to abandon
our longstanding support for conditional PUHCA repeal.
Before discussing the SEC's current views on PUHCA, it is
useful to review the history of the SEC's longstanding support
of repeal. As you know, PUHCA was enacted in 1935 in response
to abuses that had occurred in the gas and electric industry
during the first quarter of the last century. These abuses
included misuse of the holding company structure, inadequate
disclosure of the financial position and earning power of
holding companies, unsound accounting practices, excessive debt
issuances, and abusive affiliate transactions. The 1935 act was
enacted to address these problems.
In the early 1980's, however, the SEC concluded that many
aspects of the 1935 act duplicated other State and Federal
regulation. In addition, changes in the investment banking
industry had provided investors and consumers with additional
protections unforeseen in 1935. The SEC, thus, unanimously
recommended that Congress repeal the 1935 act.
However, repeal legislation was not enacted during the
1980's.
In response to accelerating changes in the utility industry
during the early 1990's, in 1994, then-Chairman Arthur Levitt
directed the SEC's staff to undertake a study of the 1935 act.
The resulting report both recommended repeal and identified
areas in which the Commission could adopt administrative
initiatives to streamline regulation under the 1935 act.
Currently, as I have indicated, the Commission continues to
support repeal of PUHCA as long as repeal is accomplished in a
way that gives the Federal Energy Regulatory Commission and
State regulators sufficient authority to protect utility
consumers. Not surprisingly, however, in light of recent
events, there are those who are now asking whether Enron's
collapse should cause those who support PUHCA repeal to
reconsider.
As I stated at the beginning of my testimony, the harm that
Enron's collapse has tragically inflicted on that company's
investors and employees is now readily apparent.
Enron is currently an exempt holding company under PUHCA.
When Enron acquired Portland General Electric in 1998, it
claimed an exemption under our rule 2 under PUHCA as an
intrastate holding company. Enron was able to claim this
exemption because it was incorporated in Oregon, Portland
General, its only utility subsidiary, was incorporated in
Oregon, and Portland General's utility operations were located
in Oregon. Enron recently agreed to sell Portland General to
Northwest Natural Gas, a transaction that is subject to
Commission approval under PUHCA.
In 1994, Enron Power Marketing Inc., a subsidiary of Enron,
received a no-action letter from the staff in our Division of
Investment Management in which the staff agreed not to
recommend enforcement action against Enron Power if it engaged
in power marketing activities without its or Enron's
registering under the 1935 act. In its request for no-action
relief, Enron Power argued that the contracts, books, records,
and other materials underlying its power marketing activities
were not ``facilities used for the generation, transmission, or
distribution of electric energy for sale;'' that the power
market subsidiary was, therefore, not an electric company for
purposes of PUHCA; and that Enron was, thus, not a utility
holding company for purposes of PUHCA. Enron Power's request
stated that at the time other companies were already engaged in
similar power marketing activities. The staff gave Enron Power
the requested no-action relief. Since that time, the staff has
given analogous no-action relief to approximately 20 other
companies.
With respect to PUHCA, as we continue to investigate and
learn from the events surrounding Enron's collapse, we remain
open-minded and, of course, will reconsider our views on repeal
if warranted. Currently, however, it appears that the tragic
collapse of Enron is not a result of its classification or lack
of classification as a public utility holding company.
Enron is a tragedy for the entire system of disclosure
regulation.
All investors, including investors in the public utility
holding companies, are entitled to a regulatory system that
produces disclosure that is meaningful and intelligible. To
address flaws in the current system, we are considering ways to
ensure that investors receive more current disclosure, better
disclosure of trend and evaluative data, and clear and
informative financial statements.
Likewise, in order to prevent our system of accounting from
being abused, whether by public utility holding companies or
other types of companies, we are working to establish a better
system of private regulation of the accounting profession and
to make sure that the Federal Accounting Standards Board, or
FASB, responds expeditiously and clearly to establish needed
accounting standards.
As I stated earlier, we as a commission continue to believe
that Congress should repeal PUHCA in a way that ensures the
protection of utility consumers.
First, FERC and the State regulators should be given
additional authority to monitor, police, and regulate affiliate
transactions. As long as the electric and gas utilities
continue to function as monopolies, there will be a need to
protect against cross-subsidization. The best means of guarding
against such cross-subsidization is likely to be audits of
books and records and Federal oversight of affiliate
transactions. Any move to repeal PUHCA should include
provisions giving FERC and State regulators the necessary tools
to engage in this type of oversight. In addition, Congress
should consider giving FERC the authority to issue rules
prohibiting or limiting those types of affiliate transactions
that it concludes are inherently abusive.
Second, repeal of PUHCA would remove barriers that now
exist to consolidation within the utility industry, as well as
barriers that prevent diversified, non-utility companies from
acquiring utilities. Removal of these restrictions may raise
competitive issues related to the market power of utilities.
Although PUHCA gives the SEC authority to review the potential
anti-competitive effects of utility acquisitions, in recent
years the SEC has looked to other regulators, such as FERC, the
Department of Justice, and the Federal Trade Commission, for
their expertise in assessing competitive issues, an approach of
``watchful deference'' to the work of our fellow regulators.
Therefore, repeal of PUHCA is unlikely to affect how market
power issues are reviewed at the Federal level. Nonetheless,
because repeal of PUHCA may increase consolidation in the
utility industry, Congress could conclude that provisions such
as section 202 of S. 1766 are necessary to give FERC sufficient
authority to ensure that what consolidation does occur in the
utility industry does not harm consumers.
Third, I know that Congress and others are considering
other types of consumer protections in the utility area. For
example, there has been discussion of whether FERC needs
additional ratemaking authority in the wholesale electricity
markets. Likewise, there has been discussion of whether FERC or
the Commodity Futures Trading Commission should be given
additional authority to oversee trading in energy-related
derivatives to prevent manipulation. While I recognize that it
is important for Congress to consider issues of these types,
the SEC does not have statutory authority to regulate utility
rates under PUHCA. Likewise, PUHCA does not give the SEC
authority to attempt to prevent manipulation in the energy
trading markets. The SEC therefore lacks the expertise to
express a view on whether reforms are needed in these two just-
mentioned areas.
Finally, repealing the act should not be viewed as a magic
solution to the current problems facing the U.S. utility
industry. For example, because the act does not currently limit
investment in generation facilities, repeal would not directly
affect the supply of electricity in the United States. Instead,
repeal of the act would eliminate regulatory restrictions that
prohibit utility holding companies from owning utilities in
different parts of the country and that prevent non-utility
businesses from acquiring regulated utilities.
Repeal of the act would also eliminate any impediment that
exists to other regulators' attempts to modernize regulation of
the utility industry. For example, during the past year,
questions have arisen about how the act will impact the ability
of FERC to implement its plans to restructure the control of
transmission facilities in the United States. While we believe
that we have the necessary authority under the act to deal with
the issues created by FERC's restructuring, without impeding
that restructuring, repeal of the act would, nonetheless,
effectively resolve those issues.
This example, however, raises the broader issue of the
relationship between FERC's and the SEC's regulation of the
utility industry. FERC is clearly the agency that Congress
intended to take the lead role in regulating the utility
industry. The SEC, in contrast, as you know, is primarily
devoted to regulating the securities markets. Although we
always attempt to work together with FERC to ensure that, to
the extent possible, our regulation of utility holding
companies under PUHCA does not impede FERC's ability to
regulate the utility industry, sometimes conflict is
inevitable. Given this, if Congress chooses not to repeal
PUHCA, we believe that responsibility for that act, whether in
its current form or in a modified form, should be transferred
from the SEC to FERC. Given the nature of FERC's
responsibilities and its expertise in regulating the utility
industry, it is simply in a better position to balance the
goals of PUHCA and the other statutes it administers and
thereby regulate the utility industry in a more consistent and
effective manner.
The SEC takes seriously its duties to administer faithfully
the letter and spirit of the 1935 act and is committed to
promoting the fairness, liquidity, and efficiency of the U.S.
securities markets. By supporting conditional repeal of the
1935 act, the SEC hopes to reduce unnecessary regulatory
burdens on America's energy industry, while providing adequate
protections for energy consumers.
Thank you, Mr. Chairman. I would be glad to try to answer
any questions you might have.
[The prepared statement of Mr. Hunt follows:]
Prepared Statement of Isaac C. Hunt, Jr., Commissioner,
Securities and Exchange Commission
I. INTRODUCTION
Chairman Bingaman, Ranking Member Murkowski, and Members of the
Committee: I am pleased to have this opportunity to testify before you
on behalf of the Securities and Exchange Commission (``SEC'') regarding
the provisions in Title II of S. 1766, the Energy Policy Act of 2002,
that would repeal much of the Public Utility Holding Company Act of
1935 (``PUHCA'' or ``the Act''). As you know, for almost twenty years
the SEC has consistently supported repeal of those provisions of PUHCA
that either duplicate laws administered by other regulators or that are
no longer necessary. The SEC has always stressed, however, that in
order to protect the customers of multistate, diversified utility
holding companies, it is necessary to give the Federal Energy
Regulatory Commission (``FERC'') and state regulators authority over
the books and records of holding companies and authority to regulate
their ability to engage in affiliate transactions. Since I last
testified on PUHCA repeal in December, the magnitude of the Enron
debacle, and the harm that Enron's collapse has tragically inflicted on
the company's investors and employees, has become clearer. Congress and
various regulatory agencies, including the SEC, are appropriately
investigating what happened at Enron, why it happened and what should
be done to prevent Enron-like debacles in the future. As we continue to
investigate and learn from the events surrounding Enron's collapse, we
remain open-minded and, of course, would reconsider our views on
conditional PUHCA repeal if warranted. Currently, however, I am not
aware of anything that would cause us to conclude that there is reason
to abandon our longstanding support for conditional PUHCA repeal.
II. BACKGROUND
Before discussing the SEC's current views on PUHCA, it is useful to
review the history of the SEC's longstanding support of repeal. PUHCA
was enacted in 1935 in response to abuses that had occurred in the gas
and electric industry during the first quarter of the last century.\1\
The abuses included misuse of the holding company structure, inadequate
disclosure of the financial position and earning power of holding
companies, unsound accounting practices, excessive debt issuances, and
abusive affiliate transactions.
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\1\ See 1935 Act section 1(b), 15 U.S.C. Sec. 79a(b).
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The 1935 Act addressed these problems by giving the Commission
authority over various practices of holding companies, including their
issuance of securities and their ability to engage in affiliate
transactions. The Act also placed restrictions on the geographic scope
of holding company systems and limited registered holding companies to
activities related to their gas or electric businesses. Because of its
role in addressing issues involving securities and financings, the SEC
was charged with administering the Act. In the years following the
passage of the 1935 Act, the SEC worked to reorganize and simplify
existing public utility holding companies in order to eliminate abuses.
In the early 1980s, however, the SEC concluded that many aspects of
the 1935 Act regulation had become redundant. Specifically, state
regulation had expanded and strengthened since 1935, and the SEC had
enhanced its regulation of all issuers of securities, including public
utility holding companies. The SEC therefore concluded that the 1935
Act had accomplished its basic purpose and that many of its remaining
provisions were either duplicative or were no longer necessary to
prevent the recurrence of the abuses that had led to the Act's
enactment. The SEC thus unanimously recommended that Congress repeal
the Act.\2\
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\2\ See Public Utility Holding Company Act Amendments: Hearings on
S. 1869, S. 1870 and S. 1871 Before the Subcomm. On Securities of the
Senate Comm. On Banking, Housing, and Urban Affairs, 97th Cong., 2d
Sess. 359-421 (statement of SEC).
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For a number of reasons--including continuing concern about the
potential for abuse through the use of a multistate holding company
structure, related concerns about consumer protection, and the lack of
a consensus for change--repeal legislation was not enacted during the
early 1980s. Because of continuing change in the industry, however, the
SEC continued to look at ways to administer the statute more flexibly.
In response to accelerating changes in the utility industry during
the early 1990s, in 1994, then-Chairman Arthur Levitt directed the
SEC's Division of Investment Management to undertake a study, under the
guidance of then-Commissioner Richard Y. Roberts, to examine the
continued vitality of the 1935 Act. The study was undertaken as a
result of the developments noted above and the SEC's continuing need to
respond flexibly in the administration of the 1935 Act. The purpose of
the study was to identify unnecessary and duplicative regulation, and
at the same time to identify those features of the statute that remain
appropriate in the regulation of the contemporary electric and gas
industries.\3\
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\3\ The study focused primarily on registered holding company
systems. There were, at the time of the study, 19 such systems. The
1935 Act was enacted to address problems arising from multistate
operations, and reflects a general presumption that intrastate holding
companies and certain other types of holding companies, which the 1935
Act exempts and which now number 119, are adequately regulated by local
authorities. Despite their small number, registered holding companies
account for a significant portion of the energy utility resources in
this country. As of September 30, 2001, the 27 registered holding
systems (which included 35 registered holding companies) owned 133
electric and gas utility subsidiaries, with operations in 44 states,
and in excess of 2500 nonutility subsidiaries. In financial terms, as
of September 31, 2001, the 27 registered holding company systems owned
more than $417 billion of investor-owned electric and gas utility
assets and received in excess of $173 billion in operating revenues.
The 27 registered systems represent over 40% of the assets and revenues
of the U.S. investor-owned electric utility industry and almost 50% of
all electric utility customers in the United States.
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The SEC staff worked with representatives of the utility industry,
consumer groups, trade associations, investment banks, rating agencies,
economists, state, local and federal regulators, and other interested
parties during the course of the study. In June 1995, a report of the
findings made during the study (``Report'') was issued. The staff's
Report outlined the history of the 1935 Act, described the then-current
state of the utility industry as well as the changes that were taking
place in the industry, and again recommended repeal of the 1935 Act.
The Report also outlined and recommended that the Commission adopt a
number of administrative initiatives to streamline regulation under the
Act.
Since the report was published, the utility industry in the United
States has continued to undergo rapid change. Congress has facilitated
many of these changes. For example, as a result of various amendments
to the Act, any company, including registered and exempt holding
companies, is now free to own exempt wholesale generators and foreign
utilities and to engage in a wide range of telecommunications
activities.\4\ In addition, the SEC has implemented many of the
administrative initiatives that were recommended in the Report.\5\ In
sum, during the past decade, while the SEC has continued to support
repeal of the Act, we have also recognized that we need to administer
it faithfully, while streamlining and adding flexibility to the
regulatory structure where permitted by the Act.
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\4\ Sections 32 and 33 of the Act, which were added to it by the
Energy Policy Act of 1992, permit, subject to certain conditions, the
ownership of exempt wholesale generators and foreign utility companies.
The impact of section 32 on the electricity industry is discussed in
more detail below. Section 34, which was added by the
Telecommunications Act of 1996, permits holding companies to acquire
and retain interests in companies engaged in a broad range of
telecommunications activities.
\5\ The Report recommended rule amendments to broaden exemptions
for routine financings by subsidiaries of registered holding companies
(see Holding Co. Act Release No. 26312 (June 20, 1995), 60 FR 33640
(June 28, 1995)) and to provide a new exemption for the acquisition of
interests in companies that engage in energy-related and gas-related
activities (see Holding Co. Act Release No. 26667 (Feb. 14, 1997), 62
FR 7900 (Feb. 20, 1997) (adopting Rule 58)). In addition, the Report
recommended and the SEC has implemented changes in the administration
of the Act that would permit a ``shelf'' approach for approval of
financing transactions. For example, during calendar year 2000, all
eleven of the new registered holding companies received multi-year
financing authorizations that included a wide range of debt and equity
securities. The Report further recommended a more liberal
interpretation of the Act's integration requirements which has been
carried out in our merger orders. The Report also recommended an
increased focus upon auditing regulated companies and assisting state
and local regulators in obtaining access to books, records, and
accounts. Six state public utility commissions participated in the last
three audits of the books and records of registered holding companies.
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III. REPEAL OF PUHCA
A. The Commission's Continuing Support of Repeal
As I have stated, the Commission continues to support repeal of
PUHCA, as long as repeal is accomplished in a way that gives the FERC
and state regulators sufficient authority to protect utility consumers.
Not surprisingly, however, in light of recent events, there are those
who are now asking whether Enron's collapse should cause those who
support PUHCA repeal to reconsider.
As I stated at the beginning of my testimony, the harm that Enron's
collapse has inflicted on the company's investors and employees is now
readily apparent. The SEC, various other regulatory agencies and the
Congress are now all investigating what happened at Enron, why it
happened and what should be done to prevent Enron-like debacles in the
future. These investigations are not only appropriate, but are
necessary if the implications of Enron for a broad range of policy
issues are to be fully understood. Currently, however, I am aware of
nothing with regard to Enron that would change our opinion on PUHCA
repeal.
Enron is currently an exempt holding company under PUHCA. When
Enron acquired Portland General Electric in 1998, it claimed an
exemption under rule 2, 17 C.F.R. Sec. 250.2, as an intrastate holding
company. Enron was able to claim this exemption because it was
incorporated in Oregon; Portland General, its only utility subsidiary,
was incorporated in Oregon; and Portland General's utility operations
were located in Oregon. Enron recently agreed to sell Portland General
to Northwest Natural Gas, a transaction that is subject to Commission
approval under PUHCA.
In 1994, Enron Power Marketing Inc. (``EPMI''), a subsidiary of
Enron, received a no-action letter from staff in the SEC's Division of
Investment Management in which the staff agreed not to recommend
enforcement action against EPMI if it engaged in power marketing
activities without it or Enron registering under the Act. In its
request for no-action relief, EPMI argued that the contracts, books and
records and other materials underlying its power marketing activities
were not ``facilities used for the generation, transmission, or
distribution of electric energy for sale'' (see PUHCA Sec. 2(a)(3)),
that the power market subsidiary was therefore not an ``electric
utility company'' for purposes of PUHCA, and Enron was thus not a
utility holding company for purposes of the Act. EPMI's request stated
that, at the time, other companies were already engaged in similar
power marketing activities. The staff, without necessarily concurring
in EPMI's legal analysis, gave EPMI the requested no-action relief. The
staff has given analogous no-action relief to approximately twenty
companies.\6\
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\6\ Since that time, the Commission has given exempt and registered
holding companies the authority necessary to engage in power marketing
as a nonutility activity. For example, rule 58, 17 CFR Sec. 250.58,
which was adopted in early 1997, permits registered holding companies
to engage in ``[t]he brokering and marketing of energy commodities,
including but not limited to electricity, natural or manufactured gas
and other combustible fuels'' as a permitted nonutility activity.
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As Chairman Pitt testified before a House Subcommittee earlier this
week, the speed and tragic consequences of Enron's collapse demonstrate
the need for a variety of reforms in our administration of the
securities laws that the Chairman and others at the SEC have been
discussing in recent months. All investors, including investors in
public utility holding companies, are entitled to a regulatory system
that produces disclosure that is meaningful and intelligible. To
address flaws in the current system, we are considering ways to ensure
that investors receive more current disclosure, better disclosure of
``trend'' and ``evaluative'' data, and clear and informative financial
statements. Likewise, in order to prevent our system of accounting from
being abused, whether by public utility holding companies or other
types of companies, we are working to establish a better system of
private regulation of the accounting profession and to make sure that
the FASB responds expeditiously and clearly to establish needed
accounting standards.
Enron is a tragedy for our entire system of disclosure regulation.
What happened to investors of Enron should be prevented from happening
to investors in any company. However, the tragic collapse of Enron is
not a result of its classification or lack of classification as a
public utility holding company.
B. Affiliate Transactions and Cross-Subsidization
Thus, we continue to believe that repeal of PUHCA will not
sacrifice any needed investor protections. As we have testified in the
past, however, we continue to believe that, in order to provide needed
protection to utility consumers, the FERC and state regulators should
be given additional authority to monitor, police, and regulate
affiliate transactions.
Specifically, although deregulation is changing the way utilities
operate in some states, electric and gas utilities have historically
functioned as monopolies whose rates are regulated by state
authorities. Some regulators subject these rates to greater scrutiny
than others. There is a continuing risk that a monopoly, if left
unguarded, could charge higher rates and use the additional funds to
subsidize affiliated businesses in order to boost its competitive
position in other markets. Because repeal of PUHCA would eliminate
existing restrictions on both the size of utility holding companies and
their ability to engage in non-utility activities, this risk may be
magnified if holding company systems become bigger and more complex.
Thus, so long as electric and gas utilities continue to function as
monopolies, the need to protect against this type of cross-
subsidization will remain. The best means of guarding against cross-
subsidization is likely to be audits of books and records and federal
oversight of affiliate transactions. Any move to repeal PUHCA should
include provisions giving the FERC and state regulators the necessary
tools to engage in this type of oversight.
As we testified last year with respect to S. 206, the bill upon
which the PUHCA repeal provisions of S. 1766 appear to have been based,
S. 1766 represents a form of this type of conditional repeal. In
particular, S. 1766 would provide the FERC with the right to examine
books and records of holding companies and their affiliates that are
relevant to costs incurred by associate utility companies, in order to
protect ratepayers. S. 1766 would also provide an interested state
commission with access to such books and records (subject to protection
for confidential information), if they are relevant to costs incurred
by utility companies subject to the state commission's jurisdiction and
are needed for effective discharge of the state commission's
responsibilities in connection with a pending proceeding. S. 1766 thus
gives the FERC and state regulators the ability to review affiliate
transactions after-the-fact and to exclude unjustified costs arising
from affiliate transactions from a utility's rate base. While this is a
significant power, and one we believe that state and federal rate
regulators should possess, we also believe that Congress should
consider giving the FERC the authority to use its rulemaking authority
to prohibit or limit on a prospective basis those types of affiliate
transactions that it concludes are so abusive that they should not be
allowed.
C. Market Power Issues
Repeal of PUHCA would remove barriers that now exist to
consolidation within the utility industry as well as barriers that
prevent diversified, non-utility companies from acquiring utilities.
Removal of these restrictions may raise competitive issues related to
the ``market power'' of utilities. PUHCA was intended to address, among
other things, the concentration of control of ownership of the public-
utility industry. In particular, section 10(b)(1) of the Act requires
the SEC to disapprove a utility acquisition if it will tend toward
concentrated control of public-utility companies in a manner
detrimental to the public interest or the interest of investors or
consumers.\7\ Traditionally, the SEC's analysis of utility acquisitions
under section 10(b)(1) includes consideration of federal antitrust
policies.\8\ More specifically, the anticompetitive ramifications of an
acquisition have traditionally been considered in light of the fact
that public utilities are regulated monopolies subject to the
ratemaking authority of federal and state administrative bodies.\9\
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\7\ The SEC must also consider whether the purchase price is
reasonable; whether the purchase will unduly complicate the
capitalization of the resulting system; and whether the transaction
will serve the public interest by tending toward the economic and
efficient development of an integrated public-utility system.
\8\ Municipal Electric Association v. SEC, 413 F.2d 1052, 1056-07
(D.C. Cir. 1969) (section 10(b)(1) analysis ``must take significant
content'' from ``the federal anti-trust policies''), cited in City of
Holyoke v. SEC, 972 F.2d 358, 363; Environmental Action, Inc. v. SEC,
895 F.2d 1255, 1260 (9th Cir. 1990) (``Federal antitrust policies are
to inform the SEC's interpretation of section 10(b)(1)'').
\9\ Entergy Corp., Holding Co. Act Release No. 25952 (Dec. 17,
1993), citing Northeast Utilities, Holding Co. Act Release No. 25221,
request for reconsideration denied, Holding Co. Act Release No. 26037
(Apr. 28, 1994), remanded sub nom. Cajun Electric Power Cooperative,
Inc. v. SEC, 1994 WL 704047 (D.C. Cir. Nov. 16, 1994).
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However, the SEC is not the only agency that reviews the potential
anticompetitive effects of utility acquisitions. In many instances,
proposed utility acquisitions are subject to FERC and state approval.
Like the SEC, the FERC must consider antitrust implications of matters
before it.\10\ In addition, the potential anticompetitive effects of
utility acquisitions are independently reviewed by the Department of
Justice or the Federal Trade Commission.
---------------------------------------------------------------------------
\10\ See Gulf States Utilities Co., v. FPC, 411 U.S. 747 (1973).
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In recent years, the SEC has looked to all these regulators for
their expertise in assessing operational and competitive issues,
particularly in situations in which the combined entity resulting from
a merger would have control of key transmission facilities and of
surplus power. Thus, although the SEC does independently assess the
transaction under the standards of PUHCA, we have generally relied upon
the FERC's greater expertise regarding issues related to utility
competition. The Court of Appeals for the District of Columbia Circuit
has stated that ``when the SEC and another regulatory agency both have
jurisdiction over a particular transaction, the SEC may `watchfully
defer' to the proceedings held before--and the result reached by--that
other agency.'' \11\
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\11\ Madison Gas and Electric Company v. SEC, 168 F.3d 1337, (D.C.
Cir. 1999); City of Holyoke v. SEC, supra note 10, citing Wisconsin's
Environmental Decade, Inc. v. SEC, 882 F.2d 523 (D.C. Cir. 1989).
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Therefore, repeal of PUHCA is unlikely to affect how market power
issues are reviewed at the federal level. While PUHCA provides an
additional layer of regulatory approval for certain utility mergers,
the Commission's reliance, where appropriate, on other regulators for
the key market power determination make its review of market power
issues largely redundant. Nonetheless, because repeal of PUHCA may
increase consolidation in the utility industry, Congress could conclude
that provisions such as section 202 of S. 1766 are necessary to give
the FERC sufficient authority to ensure that what consolidation does
occur in the utility industry does not harm consumers.
D. Other Consumer Protection Issues
I know that Congress and others are considering other types of
consumer protections in the utility area. For example, there has been
discussion of whether the FERC needs additional ratemaking authority in
the wholesale electricity markets. Likewise, there has been discussion
of whether the FERC or the Commodity Futures Trading Commission should
be given additional authority to oversee trading in energy-related
derivatives to prevent market manipulation. While I recognize that it
is important for Congress to consider issues of these types, the SEC
does not have statutory authority to regulate utility rates under
PUHCA. Likewise, PUHCA does not give the SEC authority to attempt to
prevent manipulation in the energy trading markets. The SEC therefore
lacks the expertise to express a view on whether reforms are needed in
these areas.
E. PUHCA Repeal and National Energy Policy
Repealing the Act is not, however, a magic solution to the current
problems facing the U.S. utility industry. PUHCA repeal can be viewed
as part of the needed response to the current energy problems facing
the country--notably, the Administration's recent report on energy
policy includes a recommendation that PUHCA be repealed.\12\ But repeal
of the Act will not have any direct effect on the supply of electricity
in the United States. The Act does not, for example, currently place
significant restrictions on the construction of new generation
facilities. As part of the Energy Policy Act, Congress amended the Act
in 1992 to remove most restrictions on the ability of registered and
exempt holding companies (as well as companies not otherwise subject to
PUHCA) to build, acquire and own generating facilities anywhere in the
United States. These types of facilities--exempt wholesale generators
or ``EWGs''--are not considered to be electric utility companies under
PUHCA, and, in fact, are exempt from all provisions of PUHCA. The only
limitation that remains under PUHCA is one imposed by Congress on
registered holding companies' investments in EWGs--namely, that a
registered company may not finance its EWG investments in a way that
may ``have a substantial adverse impact on the financial integrity of
the registered holding company system.'' \13\ In short, the Energy
Policy Act removed restrictions on the ability of registered and exempt
holding companies to build, acquire and own generating facilities
anywhere in the United States. As a result, a number of registered
holding companies now have large subsidiaries that own generating
facilities nationwide. Numerous other companies not subject to the Act
have also entered the generation business.\14\
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\12\ See National Energy Policy: Report of the National Energy
Policy Development Group at 5-12 (May 2001) (recommending the reform of
``outdated federal electricity laws, such as the Public Utility Holding
Company Act'').
\13\ While no Commission approval is required for the acquisition
of an EWG as a result of the Energy Policy Act, Commission approval is
required, for example, before a registered holding company can issue
securities to finance the acquisition of, or guarantee securities
issued by, an EWG. Under the Energy Policy Act, Congress directed the
SEC to adopt rules with respect to registered holding companies' EWG
investments. Pursuant to these requirements, in 1993 the SEC adopted
rules 53 and 54 to protect consumers and investors from any substantial
adverse effect associated with investments in EWGs. Rule 53 created a
partial safe harbor for EWG financings. Rule 53 describes circumstances
in which the issue or sale of a security for purposes of financing the
acquisition of an EWG, or the guarantee of a security of an EWG, will
be deemed not to have a substantial adverse impact on the financial
integrity of the system. For transactions outside the Rule 53 safe
harbor, a registered holding company must obtain SEC approval of the
amount it wishes to invest in EWGs. The standards that the SEC uses in
assessing applications of this type are laid out in Rule 53(c).
\14\ See, e.g., National Energy Policy: Report of the National
Energy Policy Development Group at 5-11 (May 2001) (noting that
``[m]ost new electricity generation is being built not by regulated
utilities, but by independent power producers'').
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Instead, repeal of the Act would eliminate regulatory restrictions
that prohibit utility holding companies from owning utilities in
different parts of the country and that prevent nonutility businesses
from acquiring regulated utilities. In particular, repeal of the
restrictions on geographic scope and other businesses would remove the
impediments created by the Act to capital flowing into the industry
from sources outside the existing utility industry. Repeal would thus
likely have the greatest impact on both the continuing consolidation of
the utility business as well as the entry of new companies into the
utility business.
Repeal of the Act would also eliminate any impediments that exist
to other regulators' attempts to modernize regulation of the utility
industry. For example, during the past year, questions have arisen
about how the Act will impact the ability of the FERC to implement its
plans to restructure the control of transmission facilities in the
United States.\15\ Specifically, in order to ``ensure that electricity
consumers pay the lowest price possible for reliable service,'' the
FERC recently implemented new regulations designed to create
``independent regionally operated transmission grids'' that are meant
to ``enhance the benefits of competitive electricity markets.'' \16\ As
a result of FERC's new regulations, many utilities will cede operating
control--and in some cases, actual ownership--of their transmission
facilities to newly-created entities. The status of these entities, as
well as the status of utility systems or other companies that invest in
them, raise a number of issues under the Act. Most prominently, it has
been asserted that the limits the Act places on the other businesses in
which a utility holding company can engage will create obstacles for
nonutility companies that may wish to invest in or operate these new
transmission entities. While the SEC believes it has the necessary
authority under the Act to deal with the issues created by the FERC's
restructuring without impeding that restructuring, repeal of the Act
would nonetheless effectively resolve these issues.
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\15\ See FERC Order 2000, ``Regional Transmission Organizations,''
65 FR 810 (Jan. 6, 2000) (codified at 18 C.F.R. Sec. 35.34).
\16\ Order 2000, 65 FR at 811.
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This example, however, raises the broader issue of the relationship
between the FERC's and the SEC's regulation of the utility industry.
The FERC is clearly the agency that Congress intended to take the lead
role in regulating the utility industry. The SEC, in contrast, is
primarily devoted to regulating the securities markets. Although we
always attempt to work together with the FERC to ensure that, to the
extent possible, our regulation of utility holding companies under
PUHCA does not impede their ability to regulate the utility industry,
sometimes conflict is inevitable. Given this, if Congress chooses not
to repeal PUHCA, we believe that responsibility for the Act, whether in
its current form or in a modified form, should be transferred from the
SEC to the FERC. Given the nature of the FERC's responsibilities and
its expertise in regulating the utility industry, it is simply in a
better position to balance the goals of PUHCA and the other statutes it
administers, and thereby regulate the utility industry in a more
consistent and effective manner.
* * * *
The SEC takes seriously its duties to administer faithfully the
letter and spirit of the 1935 Act and is committed to promoting the
fairness, liquidity, and efficiency of the United States securities
markets. By supporting conditional repeal of the 1935 Act, the SEC
hopes to reduce unnecessary regulatory burdens on America's energy
industry while providing adequate protections for energy consumers.
The Chairman. Thank you very much, Commissioner Hunt.
Let me go ahead with Mr. Hemmingway. We appreciate your
being here, and go right ahead with your testimony.
STATEMENT OF ROY HEMMINGWAY, CHAIRMAN, OREGON PUBLIC UTILITY
COMMISSION, SALEM, OR
Mr. Hemmingway. Mr. Chairman, members of the committee, my
name is Roy Hemmingway. I am the chairman of the Oregon Public
Utility Commission. I am here today on behalf of the National
Association of Regulatory Utility Commissioners, commonly known
as NARUC. I appreciate the opportunity to testify before you
today, and I wish to have my written remarks included in the
record and I will summarize those written remarks.
NARUC supports the provisions found in S. 1766, sections
223 through 228, as they pertain to reform of the Public
Utility Holding Company Act and increasing Federal and State
access to books and records, as well as moving Federal
responsibility over holding companies to the Federal Energy
Regulatory Commission.
In 1935, Congress enacted PUHCA in response to widespread
financial abuse of electric and gas consumers and investors by
multistate holding companies. Incidentally, the Holding Company
Act was signed into law almost simultaneously with the Federal
Power Act, which created the Federal Power Commission, which
eventually became FERC.
PUHCA had three basic goals: to simplify corporate
structure of utility companies so that they would aid Federal
and State regulatory efforts; second, to focus utility
management on the efficient operation of an integrated utility
company operating in a limited geographic area and restricting
diversification; and three, to protect utility consumers and
investors through the disclosure of appropriate information,
limitations on issuance of securities and guarantees, and
regulation of inter-affiliate contracting practices within
holding company systems.
There have been three significant changes to PUHCA in
recent years. In the Public Utility Regulatory Policies Act of
1978, PURPA, Congress exempted owners of cogeneration and small
powerplants from PUHCA's restriction on ownership of generating
facilities. In 1992, in the Energy Policy Act, Congress
exempted owners of any powerplant selling power exclusively at
wholesale or an owner of a utility operating in a foreign
country from the same restrictions. And in the
Telecommunications Act of 1996, Congress amended PUHCA to allow
utility holding companies to own subsidiaries providing
telecommunications.
PUHCA, for the last 65 years, has been the principal
determinant of the structure of the electric and natural gas
utility industries. Repeal of PUHCA, although it is appropriate
today, will require the addition of regulatory tools to prevent
shifts in the structure of those industries from negatively
affecting the consumers whom we as State commissioners are
sworn to protect.
The energy utility industries today are the least
concentrated major industries in the Nation. Over 100 different
investor-owned utilities serve electricity customers and about
200 natural gas utilities serve customers today. There is no
question that creating so many simply structured,
geographically distinct entities was in the public interest 6
decades ago. These small companies were easier to regulate,
were big enough to capture the economies of scale of the day,
and provided greater assurance of responsiveness to local needs
than did the absentee owners of their predecessor holding
companies.
Repeal of PUHCA will likely lead to greater consolidation
of the energy utility industry. As more local companies merge,
more of their costs become federally jurisdictional and States
lose some of their regulatory power. This shift away from State
jurisdiction is happening in any case in the electricity
industry, as increasing amounts of electricity are traded in
the federally regulated wholesale market, relative to the
State-regulated, utility-owned generation.
Today, it is questionable whether the industry structure
mandated by the Holding Company Act is appropriate for a
national electricity system characterized by active competitive
markets. If the Holding Company Act is repealed, the Federal
Government will no longer be mandating this industry structure
that has resulted in so many relatively small utility companies
that are geographically distinct. And States have some concerns
about greater consolidation and greater complexity that is
likely to result even if PUHCA repeal is a desired result. As a
State commissioner, I have concerns about diversification into
non-utility areas, about utilities dealing with affiliated
interests, and the potential cross-subsidization of these
interests from the regulated enterprises.
Access to books and records by State and Federal regulators
of all the affiliates of a holding company is a very important
tool for regulators in dealing with complex corporate
structures involving utilities.
In addition, continuing my authority as a State regulator
over mergers and strengthening FERC's authority over mergers is
an important aspect of what needs to be done if PUHCA is
repealed.
Finally, I think it is difficult to predict what will
happen in the electricity and natural gas industries once PUHCA
is repealed. The degree of consolidation and concentration that
may result is not possible to predict today, and the problems
that may result I think are not possible to predict. So, I urge
this committee and the Congress to continue to monitor these
industries. The Department of Justice, the Federal Trade
Commission also should be actively involved in monitoring the
developments in these industries if PUHCA is repealed.
That concludes my testimony, Mr. Chairman. I will be happy
to answer questions at the appropriate time.
[The prepared statement of Mr. Hemmingway follows:]
Prepared Statement of Roy Hemmingway, Chairman, Oregon Public Utility
Commission, Salem, OR
Mr. Chairman and Members of the Committee: My name is Roy
Hemmingway. I am the Chairman of the Oregon Public Utility Commission.
I am here today on behalf of the National Association of Regulatory
Utility Commissioners, commonly known as NARUC. I greatly appreciate
the opportunity to appear before the Senate Committee on Energy and
Natural Resources and I respectfully request that NARUC's written
statement be included in today's hearing record as if fully read.
NARUC is a quasi-governmental, nonprofit organization founded in
1889. Its membership includes the State public utility commissions for
all States and territories. NARUC's mission is to serve the public
interest by improving the quality and effectiveness of public utility
regulation. NARUC's members regulate the retail rates and services of
electric, gas, water and telephone utilities. We have the obligation
under State law to ensure the establishment and maintenance of such
energy utility services as may be required by the public convenience
and necessity, and to ensure that such services are provided at rates
and conditions that are just, reasonable and nondiscriminatory for all
consumers.
NARUC supports the provisions found in S. 1766, sections 223
through 228 as they pertain to reform of the Public Utility Holding
Company Act (PUHCA) and increasing Federal and State access to books
and records as well as moving Federal responsibility to the FERC.
Access to books and records required to verify transactions directly
affecting a companies regulated utility operations is of vital
importance to State commissions. Requests for such books and records by
a commission, its staff, or its authorized agents should be deemed
presumptively valid, material, and relevant, with the burden falling to
the company to prove otherwise.
Additionally, the company should be required to commit to providing
an audit trail for all corporate and affiliate transactions that impact
the companies regulated utility operations. This would give a great
deal of access to the State Commission for information that will be
needed to audit affiliated activities of a company on a going-forward
basis. More importantly, this will greatly diminish the burden of a
State Commission and its staff to have to prove each time requested,
the need to gain access to the books and records. On the other hand,
the companies are protected from potential requests for access to books
and records not pertaining to utility operations. Thus, these
provisions have a symmetry which balances the regulators need to see
with the companies' need to protect.
In 1935, Congress enacted PUHCA in response to widespread financial
abuse of electric and gas consumers and investors by multistate holding
companies. PUHCA had three basic goals. (1) To simplify the corporate
structures of utility holding companies to aid State and Federal
regulatory commissions in their efforts to regulate the rates and
services of their utility subsidiaries; (2) To focus utility management
on the efficient operation of an integrated utility company operating
in a limited geographic area and to restrict diversification into non-
utility activities; and (3) To protect utility consumers and investors
through the disclosure of appropriate information, limitations on
issuance of securities and guarantees, and regulation of inter-
affiliate contracting practices within holding company systems.
There have been three significant changes to PUHCA in recent years.
In the Public Utility Regulatory Policies Act of 1978, Congress
exempted owners of cogeneration and small power plans from PUHCA's
restrictions on ownership of generating facilities. In the Energy
Policy Act of 1992, Congress exempted owners of any power plant selling
power exclusively at wholesale or any owner of a utility operating in a
foreign country from the same restrictions. In the Telecommunications
Act of 1996, Congress amended PUHCA to allow utility holding companies
to own subsidiaries providing telecommunications service.
I want to focus now on three issues regarding repeal of PUHCA.
These are issues around industry structure, utility diversification,
and utility transactions with affiliates.
INDUSTRY STRUCTURE
PUHCA, for the last 65 years, has been the principal determinant of
the structure of the electric and natural gas utility industries.
Repeal of PUHCA, although it may well be appropriate today, will
require the addition of regulatory tools to prevent shifts in the
structure of those industries from negatively affecting consumers.
The energy utility industries are today the least concentrated
major industries in the nation. Over a hundred different investor-owned
electric utilities and about 200 natural gas utilities serve customers
today. There is no question that creating so many simply structured,
geographically distinct entities was in the public interest six decades
ago. These small companies were easier to regulate, were big enough to
capture the economies of scale of the day, and provided greater
assurance of responsiveness to local needs than did the absentee owners
of their predecessor holding companies.
Repeal of PUHCA will likely lead to greater consolidation in the
energy utility industry. As more local companies merge, more of their
costs become federally jurisdictional, and states lose some of their
regulatory power. This shift away from state jurisdiction is happening
in any case in the electricity industry, as increasing amounts of
electricity are traded in the federally regulated wholesale market
relative to state-regulated, utility-owned generation.
Today, it is questionable whether the industry structure mandated
by PUHCA is appropriate for a national electricity system characterized
by active competitive markets. Repeal of the structural requirements of
PUHCA, coupled with FERC review of mergers, will allow for the market
to decide the appropriate level of industry concentration without
bringing too much risk of concentrations of market power.
Regardless of the changing industry structure, states need access
to the books and records of the holding company, so that they can
effectively regulate the retail utility.
DIVERSIFICATION
Shortly after the enactment of the Energy Policy Act of 1992, which
allowed electric utilities significant latitude to invest in non-
utility and foreign activities, utilities began to diversify their
investments in these non-utility and foreign ventures. Since this was
new territory for State regulators as to how to protect consumers from
the risk of these diversification efforts, some State regulators looked
to negotiate ``Chinese wall'' agreements with the companies to be filed
with the SEC. These agreements contained protective safeguards for
utility customers from the risks associated with diversification
through provisions for transfer pricing among affiliates on a basis
other than cost, for access to books and records of affiliates, and for
auditing transactions between utility and non-utility affiliates.
State commissions are responsible for protecting ratepayers from
the risks associated with diversification by utilities and their
holding companies into non-utility businesses and associated with
future acquisitions by these entities of additional utility and non-
utility businesses. Although it has become common practice for electric
utilities to diversify into non-utility and foreign businesses, this
diversification carries more risk than the core regulated utility
business. NARUC believes that this risk should not be borne or shifted
to the customers of the regulated utility, since the beneficiaries of
these investments are the shareholders.
Currently, absent a negotiated agreement, when a company falls
under the PUHCA, rather than having direct authority over financial
transactions, cost allocations, and affiliate transactions, State
Commissions are relegated to applying for relief as a party before the
Securities and Exchange Commission (SEC), and the SEC rarely if ever
holds hearings under PUHCA. Thus, the SEC staff makes its
recommendations to the SEC based on the exchange of paper pleadings
among parties and bypasses the traditional evidentiary process. In
general, the registered holding company structure creates opportunities
for regulatory forum shopping, in that, if a registered holding company
and its subsidiaries do not receive the cost recovery result they want
from State regulators, they can ingeniously find a way to make the
costs at issue subject to the SEC's jurisdiction under PUHCA by
creating a company in which to house such costs or moving such costs to
a common service company or by some other means.
Additionally, regulation by the SEC under PUHCA has been greatly
relaxed since the 1980s with regard to its interpretation to meet
changing circumstances in the industry. The SEC staff, which is at a
minimal level, is not adequate to conduct compliance audits of the
numerous registered holding companies under its jurisdiction, while the
number of registered holding companies has increased significantly in
recent years. In fact, the SEC staff has, in the past, solicited the
help of State regulatory auditors in these undertakings. However,
States may not always benefit from participating in such joint audits
with the SEC. Participating State auditors could have difficulty
obtaining confidential data from the company being audited because the
company can protest as to whether the State had clear authority to
access this data.
In sum, the SEC cannot and does not adequately protect retail
customers from the risks of diversification by holding companies and
their affiliate enterprises.
TRANSACTIONS WITH AFFILIATES
Section 13 of PUHCA and related regulations generally govern the
oversight by the SEC of contracts for goods and services among
affiliated companies. Section 13, and the implementation of Section 13
by the SEC, is inadequate for addressing abusive affiliate
transactions. The allocation of common overhead costs anticipated to be
consolidated as a result of the merger would fall under the regulation
of the SEC under PUHCA, including the use of the ``at cost'' standard
for affiliate transactions, regardless of whether the SEC requires the
creation of a separate service company to house these common overhead
functions.
As I alluded to earlier, abusive affiliate transactions, including
intercompany loans and stock issuances and price gouging, led to the
enactment of PUHCA in the first place. Although most of these abuses
were cleaned up as a result of PUHCA's passage, there is still ample
opportunity for registered holding companies to pass off bad business
decisions to the regulated utility side of their businesses. Thus,
there is a concern that the SEC's ``at cost'' standard can prevent
State regulators from exercising meaningful authority over the prudence
of a utility's business dealings with its affiliated companies. If
these affiliates happen to be in non-utility businesses, the
possibility of cross-subsidization of unregulated activities by
regulated utilities also arises.
PUHCA insured that affiliate transactions could occur only at cost,
thus slamming the lid on affiliates charging prices way above cost to
their sister utility companies for goods and services. There have been
cases where the ``cost'' of an affiliate for a good or service exceeds
what a utility could buy the same good or service for in the market.
For example, suppose that a registered holding company creates a
subsidiary to buy real estate and lease it back to its affiliate
utility subsidiaries. Suppose that the real estate subsidiary leases
the building to the utility subsidiaries for $10 million annually,
which is cost. Under the SEC's ``at cost'' rule for affiliate
transaction pricing, the regulated utility subsidiaries would pay and
charge their ratepayers $10 million annually, without reference to the
current market for similar real estate in the area. If the same utility
subsidiaries could lease office space for $5 million annually in the
local market, then under the ``at cost'' rule for affiliate
transactions, ratepayers would be subsidizing the activities of the
real estate subsidiary. These circumstances are very similar to those
in the Ohio Power case, where the utility subsidiary was forced to pay
the costs of coal from its affiliated coal company, which exceeded
market coal prices by 30 percent. Thus, affiliate transactions can
raise the issue not only of imprudent decision-making, but also of
handcuffing state regulators under pre-emption by the SEC under PUHCA.
In conclusion, NARUC believes that Congress should reform PUHCA in
the manner proposed in S. 1766, but in doing so, should allow the
States to protect the public through maintaining effective oversight of
holding company practices and expanding State access to holding company
books and records, independent of any similar authorities granted to
the federal regulatory bodies. NARUC also believes that given recent
events, FERC and the States ought to be given greater access to
corporate documents to conduct investigations into financial dealings
than is contemplated in S. 1766. Each time statutory exemptions were
made to PUHCA, safeguards to protect utility consumers were included.
The enhanced State and Federal access to data and information we have
suggested will provide consumer protection safeguards in an environment
without the PUHCA safety net as we know it today. Additionally, I have
attached to this statement, a copy of NARUC's National Electricity
Policy, adopted at our Annual Convention held last November. This
document presents NARUC's positions on those issues that help to frame
the PUHCA debate. Thank you for your attention, I look forward to your
questions.
* * * * *
NARUC's National Electricity Policy
I. GENERAL PRINCIPLES
The nation's energy policy should assure adequate, reasonably
priced, reliable, safe, and environmentally sound electricity. To
achieve this goal, Federal legislation should:
1. Encourage additional fuel- and technology-diverse supply
resources to meet the nation's growing energy demands;
2. Promote demand-side management to achieve the most efficient use
of electricity;
3. Provide for reliability standards and their enforcement;
4. Assure open and effective regional wholesale markets;
5. Minimize the environmental impacts of energy generation,
delivery and use; and
6. Respect, preserve and strengthen the States' traditional roles
in regulating distribution systems, planning, siting approval,
reliability assurance, and consumer protection.
II. DIVERSE, PLENTIFUL AND ENVIRONMENTALLY RESPONSIBLE ENERGY SUPPLIES
A. Congress should encourage environmentally responsible
electricity generation and the increased use of renewable energy
technologies as a tool to achieve fuel diversity and greater energy
security.
B. Congress should encourage domestic exploration and production of
new natural gas supplies and expansion of natural gas transmission and
delivery infrastructure in an environmentally sound manner at
reasonable costs, but should avoid an over-reliance on natural gas for
new electric generation.
C. Coal fuels a significant portion of the nation's electric power
and is expected to do so for the foreseeable future. However, because
of coal's air emissions, it is important that Congress and States work
together to reduce such air emissions and encourage development of low
?polluting central station generation, including clean-coal technology.
D. Congress or the Administration should increase the efficiency
for licensing and relicensing processes of hydroelectric and nuclear
facilities, without compromising substantive environmental and safety
standards.
E. Although nuclear facilities create long-term radioactive waste
problems, they should continue to play an important part of our
national electric supply portfolio because they provide a significant
portion of the nation's electricity supply and do not produce air
emissions.
F. Congress needs to fulfill its commitment to provide the long-
term storage of spent nuclear fuel very quickly. To accomplish this,
Congress should ensure that the Nuclear Waste Fund revenue and
appropriations are managed responsibly and used only for the
establishment of a permanent repository. Pending development of a
permanent repository, it is better to store spent fuel at one (or more)
central location(s) on an interim basis than to leave it at reactor
sites.
G. The States support ongoing and renewed efforts to maintain the
security of nuclear power plants and prevent the proliferation of
weapons-grade byproducts.
H. Congress should enact legislation to lift the Public Utility
Regulatory Policies Act's mandatory purchase requirement, but should
allow the States to determine appropriate measures to protect the
public interest in resource acquisition and to address mitigation and
cost recovery issues associated with these contracts.
III. DEMAND MANAGEMENT
A. Congress should promote energy efficiency programs through
increased funding, tax credits, and the setting of increasingly more
efficient national building codes and standards for motors, lighting
and appliances.
B. Congress should promote planning strategies for maintaining a
proper balance between supply and load that includes demand-side
management techniques (including price-responsive demand mechanisms),
intermittent and renewable resources, conservation/energy efficiency
programs, as well as traditional supply and transmission options.
C. Congress should continue to provide funding for energy
efficiency and conservation for low and moderate income consumers
through programs that provide education, weatherization, housing
improvements, installation of higher efficiency appliances, and similar
usage reduction measures.
IV. RTOS, RELIABILITY, PLANNING & DELIVERY INFRASTRUCTURE
A. Regional Transmissions Organizations
1. Congress should require the FERC, in cooperation with the
States, to determine boundaries, structure, and functions for regional
transmission organizations (RTO).
2. Congress should require the FERC to give RTOs sufficient
authority to perform regional grid management, expansion, and efficient
system operations that are built and operated in the most economical,
reliable and environmentally acceptable way to realize short-term as
well as long ?term reliability and facilitate efficient wholesale
market transactions.
3. Congress should require the FERC to recognize States' rights to
active participation in RTO governance. This would include development
(and revision) of market rules, reliability and planning, access to RTO
market monitoring information, development, with federal authorities,
of market power mitigation programs.
B. Long-Term Planning
1. Congress should require that RTOs or other regional bodies have
sufficient authority to conduct long term planning for their regions
and, working with the States and transmission owners, implement long-
term planning that should:
(a) Take into account fuel diversity including renewables
resources;
(b) Recognize the need for new investment in generation and
transmission facilities that provides adequate reserve margins;
(c) Assure that reliability is not compromised by resource
imbalances;
(d) Reduce any decisional role for entities with unreasonable
generation or transmission market power;
(e) Include broad public participation and collaboration
among market participants and third party participation in
offering competitive alternatives such as demand-side and
distributed generation options;
(f) Develop a cost allocation method that is objective, non-
discriminatory, weighs environmental and societal risk, and
associates costs with benefits;
(g) Allow the use of competition, subject to appropriate
regulatory oversight, to encourage robust wholesale markets;
and
(h) Assure adequate resources in all regions of the nation.
2. Congress should support the States' authority over local
distribution utilities to provide interconnection arrangements for
self-generation and generation units that utilize the local
distribution network.
C. Reliability
1. Congress should mandate compliance with industry-developed
reliability standards on the bulk power system that includes adequate
reserve margins and preserves the authority of the States to set more
rigorous standards when deemed to be in the public interest.
2. Congress should ensure that States continue to have the
authority to establish effective price signals that allow consumers to
choose alternative levels of reliability and power quality.
D. Delivery Infrastructure
1. States should retain authority to site electric facilities,
while Congress should support the States' authority to negotiate and
enter into cooperative agreements or compacts with federal agencies and
other States to facilitate the siting and construction of electric
transmission facilities as well as to consider alternative solutions to
such facilities, such as distributed generation and energy efficiency.
2. Congress should pursue policies that promote and ensure pipeline
safety, and streamline existing siting processes to increase
administrative efficiency, including the coordination of all federal,
State and local participation in these processes, without compromising
substantive environmental and safety standards.
V. ENERGY MARKETS
A. Access to Information
1. Congress should recognize that States implementing competitive
retail markets and those with traditional regulatory structures, and
Federal, State and regional agencies and organizations overseeing the
development of wholesale energy markets require comprehensive and
timely market information. Congress should adopt policies that
safeguard public access to information necessary to enable the
monitoring of these markets, while also providing protection for
information demonstrated to be commercially, or otherwise, sensitive.
B. Retail Markets
1. Congress should not interfere with the States' authority over
all aspects of retail service including the authority to determine just
and reasonable retail rates, and those retail rates designed to
encourage reductions in peak demand and to encourage demand-side
management options.
2. Congress should not mandate retail electricity competition.
C. Wholesale markets
1. Congress should require the FERC to promulgate clear and
consistently applied market rules that foster investment in generation,
transmission and demand-side management resources.
2. Congress should mandate effective and independent monitoring of
the wholesale electricity markets and empower the relevant States and
federal agencies with authority to investigate, enforce, and remedy
problems resulting from the exercise of market power or other abusive
behavior that distorts market operations. Such remedies should include
the use of structural remedies, codes of conduct, or affiliate rules.
3. Congress should preserve a State's ability to require that a
utility's retained generation be used to serve native load.
VI. ENVIRONMENTAL PROTECTION
A. Congress should assure that State and federal energy and
environmental policies be coordinated and complementary.
B. Congress should address all air emissions from all electric
power generation in ways that: 1) minimize adverse environmental
impacts; 2) are comprehensive and synchronized to reduce regulatory
costs; 3) rely, to the extent possible, on market-based trading
mechanisms, and 4) identify, to the extent possible, the net impact of
resource decisions, including external factors, on public health, the
environment and the economy.
C. Congress should assist States and utilities to establish
programs to phase out power plants grandfathered under the Clean Air
Act with facilities that utilize clean coal technology or by other
means, in a way that preserves the integrity of the bulk power system
and minimizes the economic impact on local areas.
VII. CONSUMER PROTECTION
A. Congress should not limit State authority to prescribe and
enforce laws, regulations or procedures regarding consumer protection.
B. Congress should reinforce the States' authority to require all
load serving entities to disclose generation sources and accompanying
environmental impacts.
C. Congress should address the preservation of public benefits in
any electric industry restructuring legislation. Societal costs and
benefits should be studied prior to the adoption of any particular
implementation or funding mechanism.
D. Congress should require regional transmission organizations,
system operators, reliability counsels and other regional agencies to
adopt policies that allow public access to information necessary to
enable adequate monitoring of energy markets, while also providing
protection for information demonstrated to be commercially sensitive.
E. Congress should reform the Public Utility Holding Company Act
(PUHCA), but, in doing so, should allow the States to protect the
public through maintaining effective oversight of holding company
practices and expanding State access to holding company books and
records, independent of any similar authorities granted to the federal
regulatory bodies.
The Chairman. Thank you very much.
Ms. Marlette, why do you not go right ahead?
STATEMENT OF CYNTHIA A. MARLETTE, GENERAL COUNSEL, FEDERAL
ENERGY REGULATORY COMMISSION
Ms. Marlette. Thank you, Mr. Chairman, and members of the
committee. My name is Cynthia Marlette, and I am General
Counsel of the Federal Energy Regulatory Commission. I
appreciate the opportunity to be here today to discuss the
effects of repealing the Public Utility Holding Company Act of
1935 and whether, if PUHCA is repealed, the provisions of S.
1766 are sufficient to ensure competitive energy markets and
provide adequate customer protection.
I appear here today as a commission staff witness and I do
not speak on behalf of the commission or any one of the
commissioners.
At this critical stage in the evolution of the electric
utility industry, it is important to take all reasonable
measures to support the development of competitive energy
markets and to provide appropriate incentives for electric and
natural gas infrastructure to meet this Nation's energy needs.
Legislative reform, including repeal or reform of PUHCA, would
help to more rapidly accomplish the goal of wholesale power
competition which the Congress endorsed a decade ago in the
Energy Policy Act of 1992. However, any legislative reform must
ensure adequate protection of electric and natural gas
ratepayers from abuse of market power and inappropriate
affiliate cross-subsidization.
PUHCA, as it currently exists, may actually impede
competitive markets and appropriate competitive market
structures. In particular, it encourages greater geographic
concentrations of generation ownership which may increase
market power. Further, it may cause unnecessary regulatory
burdens for utilities who seek to form or join regional
transmission organizations, or RTO's, and it could serve as a
significant disincentive for investments in independent for-
profit transmission companies which are RTO's or which operate
under an RTO umbrella.
PUHCA should be repealed or reformed so long as the
following matters are addressed. First, Congress should ensure
that the FERC and State regulatory authorities have adequate
access to the books and records of all members of public
utility holding company systems when that information is
relevant to their statutory ratemaking responsibilities.
Second, any exemptions from a new holding company act should be
crafted narrowly. While it may be appropriate to grandfather
previously authorized activities or transactions, no holding
company should be exempt from affiliate abuse or market power
oversight.
The PUHCA repeal provision of S. 1766, as introduced on
December 5, 2001, in conjunction with other provisions in the
bill would, from the FERC regulatory standpoint, help remove
remaining competitive barriers and provide additional
regulatory tools to create and sustain competitive wholesale
power markets and to protect wholesale customers. If PUHCA if
not repealed, the Congress needs to close the current
regulatory gap, which was created by a 1992 court decision
interpreting PUHCA, which impairs the FERC's ability to protect
customers of registered holding companies from affiliate abuse
and cross-subsidization.
I appreciate the opportunity to be here, and I would be
happy to answer any questions the members may have.
[The prepared statement of Ms. Marlette follows:]
Prepared Statement of Cynthia A. Marlette, General Counsel,
Federal Energy Regulatory Commission
Mr. Chairman and Members of the Committee: Good morning. My name is
Cynthia A. Marlette, and I am General Counsel of the Federal Energy
Regulatory Commission (FERC or Commission). Thank you for the
opportunity to appear here today to discuss the effects of repealing
the Public Utility Holding Company Act of 1935 (PUHCA) and whether, if
PUHCA is repealed, the provisions of S. 1766 are sufficient to ensure
competitive energy markets and provide adequate customer protection. I
appear today as a Commission staff witness and do not speak on behalf
of the Commission or any Commissioner.
In light of the Commission's primary statutory mission and
expertise in regulating interstate transmission and rates charged in
wholesale energy markets, my comments today focus on wholesale customer
(ratepayer) protection. They do not address whether any provisions of
PUHCA or other legislative measures are necessary to protect the
interests of shareholders or employees of electric or gas holding
companies or their subsidiaries or affiliates. I defer to other
agencies with greater expertise on these important issues.
At this critical stage in the evolution of the nation's electric
industry, it is important to take all reasonable measures to support
the development of competitive energy markets and to provide
appropriate incentives for electric and natural gas infrastructure to
meet our nation's energy needs. Legislative reform, including repeal or
reform of PUHCA, would help to more rapidly accomplish the goal of
wholesale power competition which the Congress endorsed a decade ago in
the Energy Policy Act of 1992. As I will discuss further in my
testimony, the PUHCA repeal provisions of S. 1766 in conjunction with
other provisions in the bill would, from the FERC's regulatory
standpoint, help remove remaining competitive barriers, provide
additional regulatory tools to sustain competitive wholesale power
markets, and ensure adequate protection of electric and natural gas
ratepayers from abuse of market power and inappropriate cross-
subsidization.
We are now at a pivotal juncture in the development of competitive
power markets, and it is appropriate for the Congress to reexamine the
framework for regulating electric utilities, including unnecessary
restrictions that PUHCA places on the activities of certain
participants in these power markets. Although PUHCA was enacted to
protect against corporate structures that could harm investors and
ratepayers, today some of PUHCA's restrictions may actually impede
competitive markets and appropriate competitive market structures,
harming ratepayers and shareholders in the long run.
Since the legislative debate on PUHCA repeal began before the
Congress almost six years ago, two major events have caused policy
makers to more carefully examine PUHCA repeal and the adequacy of
regulatory tools and protections under existing law and under various
pending legislative proposals. These events are the California energy
crisis and the recent collapse of Enron with its devastating effects on
shareholders and employees. Both events have heightened scrutiny of
competitive markets and the appropriate regulatory framework for the
future of the electric industry. However, the majority of industry
observers, including the Commission, continue to support competitive
power markets, rather than traditional cost-based regulation, as the
best means of serving energy customers in the long run.
In past testimony, FERC witnesses have raised no objection to
repeal or reform of PUHCA, so long as certain ratepayer issues are
addressed. Today, we continue to take the position that PUHCA needs to
be repealed or reformed, so long as the following matters are
addressed:
First, Congress should ensure that the FERC and state
regulatory authorities have adequate access to the books and
records of all members of all public utility holding company
systems when that information is relevant to their statutory
ratemaking responsibilities. This is necessary to prevent
affiliate abuse and subsidization by electricity and natural
gas ratepayers of the non-regulated activities of holding
companies and their affiliates.
Second, any exemptions from a new holding company act should
be crafted narrowly. While it may be appropriate to grandfather
previously authorized activities or transactions, no holding
company should be exempt from market power and affiliate abuse
oversight.
Third, if Congress retains any existing PUHCA functions and
transfers them from the SEC to the FERC, instead of repealing
PUHCA in its entirety and replacing it with broader access to
books and records, Congress needs to provide FERC with staff
and administrative support necessary for us to carry out the
additional responsibilities.
Title II of S. 1766, as introduced on December 5, 2001, adequately
addresses the above substantive concerns with respect to PUHCA reform.
Title II of S. 1776 also provides additional regulatory tools to help
promote a competitive marketplace for electric energy and protect
wholesale customers. We believe these new provisions would
significantly enhance the Commission's current authority under the
Federal Power Act (FPA) to create and sustain competitive power markets
and ensure customer protection. The one matter that is not addressed in
S. 1766, and which would help promote a competitive marketplace and
avoid potentially lengthy litigation, is a clarification of the
Commission's authority to require regional transmission organizations
(RTOs) where it finds RTOs to be in the public interest. RTOs will
broaden regional energy markets, allow greater market efficiencies and
eliminate remaining discrimination in transmission access and grid
operations.
BACKGROUND
Under current law, the two major federal statutes affecting
electric utilities are PUHCA and the FPA. Both statutes were enacted as
part of the same legislation in 1935 to curb widespread financial
abuses that harmed electric utility investors and electricity
customers. While there is overlap in the matters addressed by these
Acts, they each have different public interest objectives. The areas of
overlap in the two statutes, and specific issues raised if PUHCA is
repealed or amended, are described in detail in the Attachment to this
testimony. As a general matter, however, the Securities and Exchange
Commission (SEC) regulates registered public utility holding companies
under PUHCA while FERC regulates the operating electric public utility
and gas pipeline subsidiaries of the registered holding companies under
the FPA and Natural Gas Act (NGA). The agencies often have
responsibility to evaluate the same general matters, but from the
perspective of different members of the holding company system and for
different purposes. The FERC focuses primarily on a transaction's
effect on utility ratepayers. The SEC focuses primarily on a
transaction's effect on corporate structure and investors.
In June 1995, the SEC issued a report entitled ``The Regulation of
Public-Utility Holding Companies'' and recommended that Congress
conditionally repeal PUHCA and enact certain ratepayer safeguards in
its place. We agree with a fundamental premise of the SEC's report that
rate regulation at the federal and state levels has become the primary
means of ensuring ratepayer protection against potential abuse of
monopoly power by utilities that are part of holding company systems.
We also believe that PUHCA, in its current form, may actually
encourage market structures that impede competition. In particular,
under PUHCA acquisitions by registered holding companies generally must
tend toward the development of an ``integrated public-utility system.''
To meet this requirement, the holding company's system must be
``physically interconnected or capable of physical interconnection''
and ``confined in its operations to a single area or region.'' This
requirement tends to create greater geographic concentrations of
generation ownership, which may increase market power and diminish
electric competition.
In addition, PUHCA may cause unnecessary regulatory burdens for
utilities who, in compliance with Commission policy and regulations,
seek to form or join RTOs. RTOs will provide the major structural
reform needed in the electric industry to mitigate market power and
operate an efficient, reliable transmission system. These institutions
will operate, or both own and operate, the interstate transmission grid
within their regions, provide transmission services on an open, non-
discriminatory basis, and perform regional transmission planning. They
may be non-profit independent system operators (ISOs), or they may be
for-profit transmission companies (transcos), or a combination of the
two. The cornerstone requirement for the institutions, however, is that
they be independent from power market participants, i.e., independent
from those that own, sell or broker generation. Under PUHCA, any entity
that owns or controls facilities used for the transmission of electric
energy--such as an RTO--falls within the definition of public utility
company, and any owner of ten percent or more of such a company would
be a holding company and potentially could be required to become a
registered holding company. This could serve as a significant
disincentive for investments in independent for-profit transcos that
qualify as RTOs or that operate under an RTO umbrella.
REVIEW OF S. 1766 TITLE II ELECTRICITY PROVISIONS
S. 1766 PUHCA Amendments
Title II, Subtitle B, of S. 1766 would repeal PUHCA and, in its
place, enact the Public Utility Holding Company Act of 2002. The new
Act would do five major things:
provide the FERC with access to books and records of holding
companies and their associate and subsidiary companies, and of
any affiliates of holding companies or their subsidiaries
(section 224);
give state commissions that have jurisdiction over a public
utility company in a public utility holding company system
access to books and records of a holding company, its
associates or affiliates (section 225);
require the FERC to promulgate a final rule, no later than
90 days after enactment, to exempt from the books and records
access requirements of section 224 any person that is a holding
company solely with respect to one or more: qualifying
facilities under the Public Utility Regulatory Policies Act of
1978; exempt wholesale generators; or foreign utility companies
(section 226);
provide that nothing in the Act precludes the FERC or a
state commission from exercising its jurisdiction under
otherwise applicable law to determine whether a public utility
or natural gas company may recover in rates any costs of an
activity performed by an associate company, or any costs of
goods or services acquired from an associate company (section
227); and
grandfather activities in which a person is legally engaged
or authorized to engage on the effective date of the new act
(section 231).
With these protections in place, and with the Commission's other
regulatory authorities under the FPA in place, we do not believe that
the S. 1766 PUHCA provisions would impair or diminish protection of
wholesale ratepayers.
If PUHCA is not repealed, however, Congress should address what has
come to be called the Ohio Power regulatory gap, which was created by a
1992 court decision and which is discussed in greater detail in the
Attachment to this testimony. Briefly, in a decision by the United
States Court of Appeals for the District of Columbia Circuit, Ohio
Power Company v. United States, 954 F.2d 779 (D.C. Cir. 1992), the
court held that if a public utility subsidiary of a registered holding
company enters into a service, sales or construction contract with an
affiliate company, the costs incurred under that affiliate contract
cannot be reviewed by FERC. The court reasoned that because the SEC has
to approve the contract before it is entered into, FERC cannot examine
the reasonableness or prudence of the costs incurred under that
contract. FERC must allow the costs to be recovered in wholesale
electric rates, even if the utility could have obtained comparable
goods or services at a lower price from a non-affiliate.
The Ohio Power decision has left a gap in rate regulation of
electric utilities. The result is that utility customers served by
registered holding companies under PUHCA have less rate protection than
customers served by non-registered systems. If PUHCA is repealed, as in
S. 1776, this problem will be solved. If the contract approval
provisions of PUHCA are retained, however, this regulatory gap should
be closed to restore FERC's ability to regulate the rates of utilities
that are members of registered holding company systems.
S. 1766 Federal Power Act Amendments
In addition to the PUHCA repeal provisions in Subtitle B of S.
1766, Subtitle A of S. 1766 contains several amendments to Part II of
the FPA: Electric Utility Merger Authority (Section 202 of Subtitle A).
Commission authority over mergers and other corporate dispositions
under FPA section 203 would be clarified or expanded to include
authority over: an electric public utility's purchase, lease or other
acquisition of existing facilities for the generation of electric
energy or for the production or transportation of natural gas; a merger
of a holding company whose holding company system includes a
transmitting utility or an electric utility company with another
holding company whose holding company system includes a transmitting
utility, electric utility company or gas utility company; and any
merger, sale, lease or disposition of generation-only facilities. In
addition, the value of facilities covered by FPA section 203 would be
increased from $50,000 to $1 million before Commission review would be
triggered.
Thus, while overlapping SEC-FERC merger review would be eliminated
by the repeal of PUHCA, the Commission's review authority would be
clarified or strengthened under the new S. 1766 provisions. This would
provide effective Federal oversight over corporate structures that
include FPA public utilities, and the effect of such structures on
wholesale competition and rates. Market-based Rate Authority (Section
203 of Subtitle A). In making a determination of whether market-based
rates are just and reasonable and not unduly discriminatory or
preferential, the Commission would be required to consider whether: the
seller and its affiliates have adequately mitigated market power;
whether the sale is made in a competitive market; whether market
mechanisms such as power exchanges and bid auctions function
adequately; the effect of demand response mechanisms; the effect of
mechanisms or requirements to ensure adequate reserve margins; and such
other considerations as the Commission may deem appropriate. Further,
if the Commission finds under section 206 of the FPA that a market-
based rate is not just and reasonable, it would determine the just and
reasonable rate and order such other action as would in the judgment of
the Commission adequately ensure a just and reasonable market-based
rate.
While this provision directs the Commission to consider matters
which it already has authority to consider under the existing FPA, it
would appear to give the Commission significant new authority to order
whatever remedies are necessary (``such other action'') to ensure
reasonable rates, once the Commission has completed its rate
investigation. Refund Effective Date (Section 204 of Subtitle A). The
refund effective date under an FPA section 206 investigation could be
as early as the date a complaint is filed or the date the Commission
issues a notice of intention to initiate an investigation. This would
provide greater refund protection for customers and a stronger
deterrence against overpricing by generators. Transmission
Interconnections (Section 205 of Subtitle A). The Commission would be
directed to establish, by rule, technical standards and procedures for
interconnection. Transmitting utilities that are not regulated as
public utilities (e.g., governmental and most electric power
cooperative entities) would be required to interconnect upon
application by a power producer or on the Commission's own motion.
This provision would strengthen the existing FPA section 210
interconnection authority of the Commission. It also would reduce
procedural costs for new generators and transmitting utilities alike
and lower overall electricity costs by helping efficient new generators
get interconnected to the transmission grid more quickly. Open Access
by Unregulated Transmitting Utilities (Section 206 of Subtitle A). The
Commission would have authority to require open access transmission
services by unregulated (governmental and most rural electric power
cooperative) transmitting utilities at rates comparable to what they
charge themselves and terms and conditions comparable to what public
utilities must offer. The Commission would be required to exempt small
entities, entities that do not own or operate transmission facilities
necessary for operating an interconnected transmission system, or
entities that meet other criteria that the Commission determines to be
in the public interest. The Commission would have authority to remand
rates to an unregulated transmitting utility.
This provision would help eliminate a major barrier to creating a
seamless national power grid, by allowing the Commission to require
open access over the approximate one-third of the transmission grid
which currently is beyond the Commission's open access authority under
sections 205 and 206 of the FPA. At the same time, the provision
recognizes the unique circumstances of governmental and rural
cooperative utilities and allows flexibility (e.g., remand of rates
that are not just and reasonable) in asserting narrow transmission
jurisdiction. This measure should produce transmission cost savings for
many customers by reducing or eliminating pancaked transmission rates
and discriminatory terms and conditions of transmission service and
interconnection. Electric Reliability Standards (Section 207 of
Subtitle A). The Commission would be required to establish and enforce
one or more systems of mandatory electric reliability standards. It
could certify one or more self-regulatory reliability organizations
which may include the North American Electric Reliability Council, one
or more regulated reliability councils, one or more RTOs, or any
similar organization to monitor and enforce compliance. This would
benefit customers by ensuring that there is Federal public interest
oversight over electric industry reliability activities, and creating
the ability to mandate compliance with what are now voluntary
standards. Market Transparency Rules (Section 208 of Subtitle A). The
Commission would be required to issue rules establishing an electronic
information system to provide information, on a timely basis, about the
availability and price of wholesale electric energy and transmission
services to the Commission, state commissions, buyers and sellers of
wholesale electric energy, users of transmission and the public. The
Commission would require each RTO to provide statistical information
about available capacity and capacity constraints on the transmission
facilities operated by the RTO and also would require each broker,
exchange or other market-making entity to provide statistical
information about the amount and sale price of sales it transacts of
electric energy at wholesale in interstate commerce. This information
would have to be posted on the Internet. The Commission would be
required to exempt from disclosure commercial or financial information
that it determines to be privileged, confidential or otherwise
sensitive.
These provisions would help prevent potential litigation about the
Commission's ability to require market information disclosure where
appropriate. They would improve market transparency through better
electronic dissemination of information about trades in the energy
markets and the transfer capabilities of the transmission
infrastructure. The measures would help the Commission establish sound
competitive wholesale markets by validating and broadening the agency's
authority to compel such reporting and information dissemination. They
also would help the Commission and financial market regulators and
players to better monitor individual companies' participation and
diminish the ability of any individual player to misbehave or
misrepresent in the marketplace. There are two cautions, however:
First, while the S. 1766 provisions address actual trades, they do
not appear to address at least two of the issues at the heart of
Enron's situation--how the Enron companies handled and reported the
risks and valuation underlying the trades they were conducting, and how
they represented the value of the trades flowing through their
platforms as corporate revenue. Those are broader financial reporting
and regulation issues that are outside the scope of the Commission's
jurisdiction and expertise.
Second, there is a difficult balance to be struck between
information that must be disclosed to make markets work and information
that is commercially proprietary. It is clearly to the public benefit
to implement rules that disclose more information and improve market
transparency, but it is not always easy in practice to find the
appropriate point between reasonable information disclosure and
protection. S. 1766's requirement to exempt commercial or financial
information that the Commission determines is privileged, confidential
or otherwise sensitive appears to give the Commission sufficient
discretion on this important matter. Access to Transmission by
Intermittent Generators (Section 209 of Subtitle A). The Commission
would be required to ensure that all transmitting utilities provide
transmission service to intermittent generators in a manner that does
not penalize such generators for characteristics that are inherent to
intermittent energy resources and are beyond the control of such
generators.
These provisions would allow more renewable energy to be integrated
into market operations at lower operating costs. This would enhance
customers' ability to choose more environmentally clean energy sources.
Enforcement (Section 210 of Subtitle A). The entities that could file a
complaint under the FPA would be expanded to include electric
utilities, and the entities against whom a complaint could be filed
would be expanded to include transmitting utilities. Similarly, the
Commission would have authority to investigate whether transmitting
utilities have violated the FPA. The Commission's civil penalty
authority under FPA section 316A ($10,0000 per day per violation) would
be extended to cover any violation under Part II of the FPA.
The Commission currently has very limited civil penalty authority
under section 316A of the FPA. This provision would significantly
expand the Commission's ability to enforce Part II of the Act which
would in turn enhance the Commission's ability to bring the benefits of
competitive electric markets to customers.
S. 1766 PURPA AMENDMENTS
Subtitle C of S. 1766 would amend some of the provisions currently
under the FERC's jurisdiction under the Public Utility Regulatory
Policies Act of 1978: Termination of Mandatory Purchase and Sale
Requirements (Section 244 of Subtitle C.) The mandatory purchase and
sale requirements of PURPA (between qualifying facilities (QFs) and
electric utilities) would be terminated; contracts existing on date of
enactment would be grandfathered; and statutory ownership limitations
for qualifying facilities would be eliminated.
These provisions would eliminate statutory requirements which are
inconsistent with today's competitive power markets but, at the same
time, would not disrupt expectations associated with pre-existing
contracts. Net Metering (Section 245 of Subtitle C). Electric utilities
would be required to make net metering service available upon request
to an electric customer that the electric utility serves. The
Commission would be permitted to adopt by rule control and testing
requirements for on-site generating facilities and net metering
systems, in addition to the other requirements in the statute, if the
Commission determines they are necessary to protect public safety and
system reliability.
CONCLUSION
Legislative reform, including repeal or reform of PUHCA, would help
to more rapidly accomplish the goal of wholesale power competition.
However, any repeal of PUHCA must ensure adequate protection of
ratepayers, including state and federal regulator access to books and
records of holding company members. The PUHCA repeal provisions of S.
1766 in conjunction with other provisions of the bill would, from the
FERC's regulatory standpoint, help remove remaining competitive
barriers and provide additional regulatory tools to sustain competitive
wholesale power markets and protect wholesale and retail customers.
Thank you again for the opportunity to be here today. I would be
happy to answer any questions you may have.
Attachment Testimony of Cynthia A. Marlette
EXISTING STATUTORY FRAMEWORK: FERC/SEC JURISDICTION
The FERC's primary function under the FPA is ratepayer protection.
The FERC regulates public utilities as defined in the FPA. These
include individuals and corporations that own or operate facilities
used for wholesale sales of electric energy in interstate commerce, or
for transmission of electric energy in interstate commerce. The FERC
does not regulate all utilities. For example, publicly-owned utilities
and most cooperatives are exempt from our traditional rate regulatory
authority.
The FERC ensures that rates, terms and conditions for wholesale
sales of electric energy and transmission are just, reasonable and not
unduly discriminatory or preferential. In addition, the FERC has
responsibilities over corporate mergers and other acquisitions and
dispositions of jurisdictional facilities, transmission access, certain
issuances of securities, interlocking directorates, and accounting. In
exercising its responsibilities, the Commission must take into account
any anticompetitive effects of jurisdictional activities.
There is overlap in the jurisdiction of the FERC and the SEC. As a
general matter, the SEC regulates registered utility holding companies
whereas the FERC regulates the operating electric utility and gas
pipeline subsidiaries of the registered holding companies. The agencies
often have responsibility to evaluate the same general matter, but from
the perspective of different members of the holding company system and
for different purposes. The FERC primarily focuses on the impact of a
transaction on utility ratepayers. The SEC, on the other hand,
primarily focuses on the impact of a transaction on corporate structure
and investors.
There are four major areas of overlap in the jurisdiction of the
FERC and the SEC with respect to regulation of the electric industry:
(1) Accounting--The SEC has authority to establish accounting
requirements for every registered holding company, and every
affiliate and subsidiary of a registered holding company. Many
of these companies are public utilities that are also under the
FERC's jurisdiction and subject to its accounting requirements.
(2) Corporate regulation--The SEC must approve the
acquisition of a public utility's securities by a registered
holding company. The FERC must approve the disposition or
acquisition of jurisdictional facilities by a public utility.
(3) Rates--The SEC must approve service, sales and
construction contracts among members of a registered holding
company system. The FERC must approve wholesale rates
reflecting the reasonable costs incurred by a public utility
under such contracts.
(4) PUHCA Exemptions--Under the PUHCA section 32 amendment
contained in the Energy Policy Act of 1992, the FERC must
determine whether an applicant meets the definition of exempt
wholesale generator, and thus is exempt from the Holding
Company Act. With minor exceptions, the SEC continues to make
PUHCA exemption determinations under the pre-Energy Policy Act
PUHCA provisions as well as under the new section 33 of PUHCA
(concerning foreign utility companies).
Congress recognized the overlap in FERC-SEC jurisdiction when it
simultaneously enacted PUHCA and the FPA in 1935. It included section
318 in the FPA, which provides that if any person is subject to both a
requirement of the FPA and PUHCA with respect to certain subject
matters, only the requirement of PUHCA will apply to such person,
unless the SEC has exempted such person from the requirements of PUHCA.
If the SEC has exempted the person from the PUHCA requirement, then the
FPA will apply.
During the half-century following enactment of PUHCA and the FPA,
there were no significant problems resulting from the overlap in FERC-
SEC jurisdiction, until a series of court decisions involving the
wholesale rates of the Ohio Power Company. Under the last of these
court decisions, a 1992 decision by the United States Court of Appeals
for the District of Columbia Circuit (Ohio Power Company v. FERC, 954
F.2d 779 (D.C. Cir. 1992) (Ohio Power)), the FERC does not have the
extent of rate jurisdiction which it previously thought it had over
public utility subsidiaries of registered electric utility holding
companies.
Under the 1992 Ohio Power decision, if a public utility subsidiary
of a registered holding company enters into a service, sales or
construction contract with an affiliate company, the costs incurred
under that affiliate contract cannot be reviewed by the FERC. The SEC
has to approve the contract before it is entered into. However, the
FERC cannot examine the reasonableness or prudence of the costs
incurred under that contract. The FERC must allow those costs to be
recovered in wholesale electric rates, even if the utility could have
obtained comparable goods or services at a lower price from a non-
affiliate.
This decision has left a major gap in rate regulation of electric
utilities. The result is that utility customers served by registered
holding companies have less rate protection than customers served by
non-registered systems. If PUHCA is repealed, the Ohio Power problem
goes away. This is a significant advantage of S. 1766, introduced
December 5, 2001. S. 1766 would repeal PUHCA and enact a new, more
limited law that does not give rise to an Ohio Power problem. Short of
repeal of PUHCA, however, the existing regulatory gap needs to be
addressed.
ISSUES RAISED IF PUHCA IS REPEALED OR AMENDED
There are several ratepayer protection issues on which Congress
should focus in considering PUHCA legislation. S. 1766 adequately
addresses these issues. An important aspect of ratepayer protection is
preventing affiliate abuse and the subsidization by ratepayers of the
non-regulated activities of non-utility affiliates. These issues can
arise in virtually every area of the FERC's responsibilities. In the
case of public utilities that are members of holding companies, there
are increased opportunities for abuses. There are several reasons for
this.
First, registered holding companies have centralized service
companies that provide a variety of services (e.g., accounting, legal,
administrative and management services) to both the regulated public
utility operating companies in the holding company system, and to the
non-regulated companies in the holding company system. The FERC's
concern in protecting ratepayers is that when the costs of these
service companies are allocated among all members of the holding
company system, the ratepayers of the public utility members bear their
fair share of the costs and no more; ratepayers should not subsidize
the non-regulated affiliates of the public utilities.
Thus far, FERC has had few, if any, problems with inappropriate
allocations of service company costs. The services provided by the
centralized service companies have been relatively limited. In recent
years, however, there has been a substantial increase in the services
being performed by these types of service company affiliates. In many
registered company systems, the majority of the costs of operating and
maintaining the operating utilities' systems, which previously were
incurred directly by each individual utility, are now being incurred by
the service company and billed to the public utility under SEC-approved
allocation methods. These costs can be significant for ratepayers. This
means that rate regulatory oversight of service company allocations is
imperative.
A second concern involves special purposes subsidiaries. In
addition to the centralized service companies, registered holding
companies increasingly are forming special purpose subsidiaries that
contract with their public utility affiliates to supply services, as
well as goods and construction. This can include fuel procurement,
services such as operation of power plants, telecommunications, and
construction of transmission lines and generating plants.
The FERC's primary concern with affiliate contracts for goods and
services is that utilities not be allowed to flow through to electric
ratepayers the costs incurred under affiliate contracts if those costs
are more than the utility would have incurred had it obtained goods or
services from a non-affiliate. As discussed earlier, under the 1935
PUHCA the FERC cannot provide adequate protection to ratepayers served
by registered systems because of the 1992 Ohio Power court decision.
The Commission recently has made some progress in protecting
customers served by registered holding companies by using its
conditioning authority over registered holding company public utilities
that seek approval to sell power at market-based rates. The Commission
has said that if such utilities want to sell at market-based rates,
they must agree not to purchase non-power goods and services from an
affiliate at an above-market price; they must agree that if they sell
non-power goods and services to an affiliate, they will do so at the
higher of their cost or a market price. However, the Commission's
market rate conditioning authority is not enough to protect all
registered system ratepayers against abusive affiliate contracts. Short
of repeal of PUHCA, legislation is needed to fully remedy the
regulatory gap.
According to the SEC's 1995 report, service companies render over
100 different types of services to the operating utilities on their
systems, with non-fuel transactions aggregating approximately $4
billion annually. This growth adds to the potential for ratepayer
subsidies involving both the centralized and the special-purpose
service companies.
Another reason for heightened concern regarding affiliate abuses in
all holding company systems, both registered and exempt, is the large
number of holding company subsidiaries that engage in non-utility
businesses. According to the SEC 1995 report, since the early 1980's
the number of non-utility subsidiaries of registered companies had
quadrupled to over 200. The trend in exempt companies is also likely to
be significant as well. The sheer number of non-utility business
activities brings greater potential for improper allocation of
centralized service company costs to the non-utility businesses (i.e.,
electric ratepayers subsidizing the non-utilities' fair share of the
costs). It also increases the opportunities for affiliate contracting
abuses.
To protect against affiliate abuse and cross-subsidization, federal
and state regulators must have access to the books, records and
accounts of public utilities and their affiliates. Under section 301 of
the FPA (and section 8 of the Natural Gas Act), the FERC has
substantial authority to obtain such access. It can obtain the books
and records of any person who controls a public utility, and of any
other company controlled by such person, insofar as they relate to
transactions with or the business of the public utility. This, however,
may not necessarily reach every member of the holding company. Thus
far, there has been no significant problem in obtaining access to books
and records and in monitoring and protecting against potential abuses.
However, the SEC's regulatory role with respect to registered systems
has been an added safeguard.
It is critical that both state and federal regulators have access
to books and records of all companies in a holding company system that
are relevant to costs incurred by an affiliated utility. This is
equally true with respect to both registered and exempted holding
company systems. If Congress modifies or repeals PUHCA, it should
clearly confirm the FERC's mandate and authority to ensure that
ratepayers are protected from affiliate abuse. Similarly, we encourage
Congress to be mindful of concerns expressed by state commissions and
provide states with appropriate access to relevant books and records of
all holding company systems.
In addition to the above ratepayer protection concerns, there are
several other matters that should be considered in analyzing PUHCA
reform. These include future corporate structures in the electric
industry, diversification activities, and the issuances of securities
affecting public utilities.
As mentioned earlier, the FERC must approve public utility mergers,
acquisitions, and dispositions of jurisdictional facilities. This is an
area in which the Commission has overlapping jurisdiction with the SEC,
but also an area in which in some instances there is no overlap.
Jurisdictional facilities under the FPA are facilities used for
transmission in interstate commerce, or for sales for resale in
interstate commerce. FERC has claimed jurisdiction over transfers of
jurisdictional sales contracts but has disclaimed jurisdiction over
dispositions that solely involve physical generation facilities. It
appears that most state regulators have authority to regulate
dispositions of physical generation assets. Further, such dispositions
or acquisitions would be subject to the antitrust laws.
The FERC does not have any explicit jurisdiction to approve or
disapprove diversification activities of public utilities or holding
companies. Thus, if PUHCA were repealed, the only federal oversight of
diversification activities of holding companies or their public utility
members would be through FERC auditing of books and records. However,
the SEC does not directly review public utility diversification
activities of other holding companies and public utilities, and this
has not posed any significant problems in the FERC's protection of
ratepayers. In addition, many state commissions regulate
diversification by public utilities that sell at retail.
A final area involves issuances of securities. The FERC must
approve issuances of securities by public utilities that are not
members of registered holding company systems, unless their security
issuances are regulated by a state commission. Because the majority of
states regulate issuances by public utilities, the FERC does not
regulate most public utilities' issuances. If PUHCA were repealed, it
appears that there would be no federal review and approval of issuances
of securities by holding companies or their public utility members. The
SEC can more appropriately address whether any federal oversight is
necessary in this area.
The Chairman. Thank you very much.
Mr. Sokol, why don't you go right ahead?
STATEMENT OF DAVID L. SOKOL, CHAIRMAN AND CEO, MIDAMERICAN
ENERGY HOLDINGS COMPANY, DES MOINES, IA
Mr. Sokol. Thank you, Mr. Chairman.
MidAmerican Energy Holding Company is a diversified
international energy company headquartered in Des Moines, Iowa,
with approximately $13 billion in assets. Our largest investor
is Berkshire Hathaway, one of the only AAA-rated industrial
companies in the United States.
I would like to commend you for your persistence in working
to include electricity modernization provisions in the Senate
energy bill. S. 1766 addresses critical issues that only
Congress can fix, covering such areas as reliability, changes
to PURPA, FERC jurisdiction over transmission assets, PUHCA
reform, a more thorough FERC merger review policy, and other
consumer protection measures and information transparency
requirements.
As you requested, I will focus on PUHCA and the specific
issues you have asked me to address which include consumer
protection, barriers to investment in market entry, and
appropriate forums for regulatory oversight.
These issues are closely linked. 10 years ago, Congress
passed the Energy Policy Act of 1992 in order to encourage open
competitive wholesale electricity markets. PUHCA, passed in
1935 at the height of the depression, remains a significant
impediment to that goal.
Our largest investor, Warren Buffett, has stated that he
would intend to invest up to $15 billion in the industry once
PUHCA is repealed or modified. Sadly, we have not invested in
the United States for the last 2 years, but we have now
purchased our second United Kingdom utility for $1.5 billion
last summer. It is absurd that PUHCA's barriers to entry limit
the ability of high credit quality investors like Berkshire
Hathaway from investing in the U.S. utility market, thus
forcing us to look overseas where we can invest more freely.
There are really two stories before this committee today.
The first is what actually happened to energy markets as a
result of the Enron collapse, and the second is the story that
is often spun by those who have long opposed market
modernization measures.
On the first story, at your hearing on this topic last
week, there was consensus that energy markets responded to the
Enron collapse with little, if any, disruption. The lights
stayed on, natural gas flowed, and the consumer prices did not
rise. This was true for the broad markets and for the consumers
of Enron's regulated subsidiary, thus proving a point that
PUHCA reform supporters have been making for almost 20 years.
Aggressive, effective State and Federal regulation are the true
keys to consumer protection.
It is hard to imagine a company collapsing more swiftly or
completely than Enron, yet the customers of its subsidiary,
Portland General Electric, have been unaffected by that
bankruptcy. This is the result of the effect of State and
Federal regulation and the ability of State PUC commissioners
to oversee issues of utility financing and cost recovery.
Now, the second story, what did not happen with Enron,
first Enron was not working to build a multistate insulate
utility empire as has been reported. To the contrary, it had
been looking to sell Portland General for over the past 2
years. In fact, Enron probably would not even have been in the
regulated utility business at the time of its collapse if PUHCA
had not hampered its efforts to exit the business.
And why is that? PUHCA artificially and materially limits
the number of buyers for any utility to those utilities that
can meet the law's physical integration provisions. For
example, we were approached 2 years ago by Enron about buying
Portland General, and in fact we concluded that we wanted to
buy them but could not because of the PUHCA restrictions.
That is what is wrong with PUHCA. It did nothing to help or
to protect Portland General, and to the contrary, by blocking
high credit worthy companies like ourselves, PUHCA has limited
Enron's options so that it is now selling the company to a
local gas utility based upon a very highly leveraged financial
structure. This is one of the core problems of the statute. It
serves as a barrier to entry of investment and results in
market concentration. This arcane and counterproductive
requirement also limits California's options as the State
considers how best to recapitalize its utilities.
Second, Enron did not lobby for PUHCA repeal. It was a
leading opponent of stand-alone PUHCA legislation and testified
before Congress numerous times that it would only support PUHCA
repeal as a tradeoff for concessions that it wanted. This
committee should also be aware that in the most recent
congressional testimony by Enron on electricity policy, Enron
opposed enhanced access to books and records, provisions that
we and most in this industry have long favored.
Third, Enron did not receive any special exemptions from
PUHCA. Enron received two PUHCA exemptions from the SEC and
both were clear cases under the law. The first was a statutory
exemption provided to more than 50 holding companies whose
utility operations are located primarily in a single State. And
the second exemption concerned a question of whether a power
marketer should be considered a public utility under PUHCA. The
issue here was also simple. Just because you engage in energy
trading does not make you a public utility subject to PUHCA. If
it did, then virtually every investment bank in America that
participates in the energy markets would also be subject to
PUHCA. The SEC decision was clearly correct under the facts and
the laws.
And what about charges the Enron collapse could have been
prevented had the company somehow been subjected to PUHCA?
Since it is clear that Enron was properly an exempt holding
company under PUHCA, this charge could only be true to the
extent that Congress intends to pass a new law like PUHCA and
apply it to every publicly traded company in America. If, as it
has been reported, a company is willing to violate the '33 and
the '34 securities acts, shred documents requested by Congress,
engage in highly questionable accounting practices, knowingly
mislead investors, and ultimately drive itself into bankruptcy,
why would PUHCA have somehow protected those shareholders?
American business executives must be held criminally and
financially accountable for their illegal activities. We do not
tell a teenager who steals from a convenience store that he can
go scot-free if he just returns half of what he stole. Why
should we adopt different standards for corporate executives
and auditors?
It may also be necessary to strengthen certain financial
laws and regulations, but those changes need to be applied to
all publicly traded companies not just to a small subset of
companies in one industry.
And at the same time, it may be appropriate to address the
oversight of the energy futures trading activities. FERC
Chairman Wood is moving aggressively to bring transparency and
vibrant competition to the wholesale electric market. Some
think he is moving too quickly; others believe he is moving too
slowly. But few would disagree with his goal or the benefits
that consumers will gain. This market will never achieve the
depth, the transparency, and the level of competition we all
seek if PUHCA's barrier to entry and investment remain in
place.
The reasons why you must eliminate the anti-competitive and
anti-consumer aspects of PUHCA are clear.
PUHCA's arbitrary limitations hurt consumers. Just last
month, the D.C. Circuit Court of Appeals, relying on PUHCA's
single region and physical integration requirement, remanded
the SEC's approval of a large utility merger between AEP and
Central and Southwest that would have produced consumer
savings, acknowledged by the court, of $2.1 billion.
The law's ownership restrictions keep capital out of one of
this country's most critical industries at a time when the
transmission sector alone requires tens of billions of dollars
of new investment.
The law's counterproductive requirements of interconnection
and geographic proximity foster regional concentration, which
runs directly counter to 50 years of antitrust law and economic
theory.
PUHCA hinders FERC's ability to establish large, multistate
regional transmission organizations.
And lastly, foreign companies are not restricted by PUHCA's
physical integration provisions, and this gives them an
advantage on their first bite entry into U.S. markets and sends
American dollars overseas.
Your bill strikes the proper balance on PUHCA reform. It
repeals the outdated provisions and strengthens consumer
protections. It endorses FERC policy and modern antitrust law
by recognizing that ownership of utility assets should not be
artificially concentrated, and that high credit quality
companies should be permitted to enter the market. At the same
time, it strengthens the books and records provisions of the
law.
If you provide regulators with better tools to protect
consumers and provide more access to the marketplace by high
quality companies, you will strengthen the U.S. electricity
market.
You cannot fix PUHCA by tinkering around its edges. The SEC
concluded in 1995 that PUHCA had accomplished its goals by
1952. It is time to repeal this law's antiquated and arbitrary
physical integration requirements and its ownership
limitations. At the same time, you can replace PUHCA with
enhanced books and records authority and other consumer
protections, as recommended by the chairman, and move the
country forward to a competitive pro-consumer market.
Thank you.
[The prepared statement of Mr. Sokol follows:]
Prepared Statement of David L. Sokol, Chairman and CEO, MidAmerican
Energy Holdings Co., Des Moines, IA
Thank you, Mr. Chairman. MidAmerican Energy Holdings Company is a
diversified, international energy company headquartered in Des Moines,
Iowa with approximately $11 billion in assets. Our largest investor is
Berkshire Hathaway, one of the only AAA-rated companies in the United
States.
The Company consists of four major subsidiaries: CE Generation
(CalEnergy) a global energy company that specializes in renewable
energy development in California, New York, Texas and the West, as well
as the Philippines; MidAmerican Energy Company, an electric and gas
utility serving the states of Iowa, Illinois, South Dakota and a small
part of Nebraska; Northern Electric, an electric and gas utility in the
United Kingdom; and HomeServices.com, a residential real estate company
operating throughout the country.
I'd like to commend you for your persistence in working to include
electricity modernization provisions in the Senate energy bill. We
cannot pass a national energy plan for the new century while leaving in
place a regulatory system that was already outdated at the end of the
last. Your bill does not seek to do everything, but it does critical
things that only Congress can do, among these are:
1. Establishing a mandatory, enforceable electric reliability
regime
2. Replacing the outdated PURPA mandatory purchase
requirement with measures to promote distributed generation and
standardize interconnection procedures
3. Bringing all owners of significant transmission assets
under FERC jurisdiction to create a more seamless interstate
system
4. Adopting a variety of consumer protection measures and
information transparency requirements
5. Replacing the PUHCA law of 1935 with enhanced regulatory
access to the books and records of all utility holding
companies while adopting a more thorough merger review policy
This package represents a consensus of those who have worked
actively in support of legislation for many years and will result in a
modernized electric infrastructure that will benefit consumers while
providing for fair competition.
As the American economy begins to recover, demands on our electric
system will increase once again, and if we have not moved forward with
the critical elements of market modernization, consumers may once again
pay the price for an outdated system. At the same time, we should
recognize that the pending recovery is tenuous and take steps to
encourage the markets and American consumers that there is bipartisan
support for positive, pro-investment initiatives.
In your invitation to testify, you specifically asked me to comment
on a number of issues related to the PUHCA law, including issues of
consumer protection, barriers to investment and market entry, and
appropriate forums for regulatory oversight.
These three issues are unavoidably linked. Ten years ago, Congress
passed the Energy Policy Act of 1992 in order to create open,
competitive wholesale electricity markets so that investors, not
consumers, would bear the risks associated with capital-intensive,
electric generation investment. That is when PUHCA changed from being
primarily a nuisance for companies to a burden for consumers.
By keeping investment dollars out of the industry and perpetuating
market fragmentation, PUHCA contributed to the failure of our electric
infrastructure to keep pace with the demands of the growing competitive
wholesale market. MidAmerican's largest investor, Warren Buffett, has
publicly announced his intention to invest as much as $15 billion in
the industry once PUHCA is repealed. However, PUHCA's barriers to entry
prevent him from making these investments, particularly in transmission
and distribution assets.
Last year, I testified in both the Senate and the House of
Representatives as to how PUHCA blocked MidAmerican from making major
investments in the California utilities that could have helped
stabilize their financial positions during the early part of the energy
crisis. PUHCA's ownership limitations and physical integration
requirements stood in the way.
PUHCA is also complicating attempts by the company to make a major
expansion of our geothermal development in the Imperial Valley in
Southern California. While we have begun a smaller project, we cannot
undertake any expansion that would require us to build significant new
transmission facilities to bring this power to the grid without
potentially running afoul of PUHCA.
Some have claimed in recent contacts to the SEC that one cannot
invest in a regulated utility asset and also make good non-utility
investments. No law can make a good investor or a bad investor. Nor
should any law determine that a person who invests in one industry
should not be able to invest in another provided there are no conflicts
of interest.
PUHCA and those who support its predetermined limitations on who
can invest in this industry take a shortsighted approach. The way to
protect consumers is not to maintain a Chinese wall around investment
in this industry it is to maintain effective separation of the
financing and rate structures of regulated utilities and their assets
and any affiliated operations.
There has not been much good news in energy markets in recent
months, and even conservatively managed traditional utilities are
feeling financial pressure. This will make it harder than ever for the
industry to raise capital and build new infrastructure. And, as
consumers in California and the West experienced in recent years,
market failure is the ultimate anti-consumer result.
PUHCA is not, and never was designed to be primarily a consumer
protection statute. The overwhelming focus of the law is on preventing
corporate malfeasance that harms investors. By eliminating financial
abuses, Congress certainly expected that consumers would benefit, but
PUHCA does not address rates, and the implementing agency, the SEC, has
no rate setting function or expertise.
Simply put, if the issue is protecting consumers from unfair rates,
FERC and the states have developed the expertise over almost seventy
years to perform these functions. The SEC has absolutely no rate-
setting function and has emphasized this fact on many occasions before
Congress.
On the issue of cross-subsidies, the appropriate protection against
cross-subsidization is the books and records access provided in the
bill. Using my own company as an example, if the state of Iowa had
concerns that MidAmerican Energy was inflating rates in our retail
electric or gas tariffs to support a competitive business in some other
state, under the bill, state regulators would have an explicit right in
federal court to gain access to the books and records of any affiliated
business in any other state that had conducted business with the
utility.
At the same time, the Committee should be wary of attempts to make
FERC some type of super-regulator of retail rates in all fifty states
in the name of stronger protections against cross-subsidization. FERC's
expertise is wholesale rates. State commissions are closest to the
details of retail rate-setting and capital structure decisions.
Muddying the water on this fairly clear distinction would be a recipe
for disaster. We've already seen during the California crisis the
debilitating impact that finger-pointing between Washington and the
states can have on effective regulation. We should not go down that
road.
The only rate-related provision of PUHCA relates to ``at cost''
pricing. While the law seeks to ensure that utilities and their
affiliates do not engage in inter-affiliate pricing schemes to inflate
consumer costs, the ``at cost'' requirement in the PUHCA law actually
limits the ability of state and federal regulators to require
registered holding companies to price some goods and services at the
lower of ``at cost'' or market rates.
Much of this ground has been well-covered in recent years. That is
why the PUHCA provisions included in this bill have been part of
virtually every electricity modernization bill introduced in the last
several Congresses, have enjoyed the support of the last four
Administrations and the regulatory agencies that enforce the laws, and
passed the Senate Banking Committee earlier this year by a 19-1 vote.
What has changed then?
We are here this morning because a few long-time opponents of
updating the PUHCA law have made new claims arising from the Enron
collapse. It's worth noting that one of these advocates stated last
December that he could support the electricity provisions of this bill
in its present form. But, I suppose that Enron fell, and opportunity
knocked.
There are really two stories before this Committee today. The first
is the story of what actually happened to energy markets as a result of
the Enron collapse. These events should reassure the Committee that you
should move forward with this legislation.
The second story is the one spun by those who have long opposed
market modernization measures. It poses a series of events that did not
happen and attempts to force supporters of PUHCA legislation to prove
that these events could not have happened. Taken to its logical
conclusion, this ``expand PUHCA'' agenda would require Congress, FERC
and the states to unravel more than a decade's efforts to create open,
vibrant and transparent energy markets.
The reason why this is so is instructive. Virtually every element
of modern competitive electricity markets exists either as an explicit
statutory exemption from PUHCA or as a result of regulatory
determinations that gave flexible interpretations to PUHCA.
A ``fundamentalist'' view of PUHCA, that every electric or gas
company that sells on the grid should be registered, would result in
complete market concentration, elimination of the marketing industry
and gutting of the EWG exemption since almost all EWGs rely on either
an affiliated marketing company or independent marketers to sell
competitive electricity.
Let's start with the first story. What happened to energy markets
as a result of the Enron collapse?
At your hearing on this topic last week there was consensus that
energy markets responded to the Enron collapse with little, if any,
disruption. The lights stayed on, natural gas flowed, and consumer
prices did not rise. This is true not only for the markets generally,
but also for wholesale and retail customers of Enron's subsidiaries.
In December, all four FERC Commissioners testified before the House
Energy and Air Quality Subcommittee that electric and gas markets had
responded to the Enron collapse with remarkable resiliency. Chairman
Wood repeated that assessment before this committee last week, along
with independent market analysts, market participants and a
representative of the state regulators.
In fact, the situation of the customers of Enron's retail electric
and gas pipeline subsidiaries proves the argument that PUHCA
legislation supporters have been making for almost twenty years, which
is that aggressive, effective state and federal regulation are the true
keys to consumer protection, not a statute that deals primarily with
details of corporate structure.
It's hard to imagine a company collapsing more swiftly or more
completely than Enron, yet the customers of Portland General and
Northern Natural Gas, Florida Gas Transmission, Transwestern Pipeline
and North Border Partners have been unaffected by the bankruptcy.
PGE's assets and operations have both regulatory and contractual
safeguards. PGE has its own legal identity as a corporation, separate
from Enron. It owns its own assets, and its management runs day-to-day
operations, and its financial health is in good standing, as confirmed
recently by several securities rating services.
This is the result of effective state and federal rate regulation
and the ability of state commissions to oversee issues of utility
financing and cost recovery. This is where real consumer protection
occurs in electric and gas markets.
On the separate issue of whether Enron had been manipulating
forward electricity markets, I commend the Committee for bringing these
concerns to light.
In December, I met with members and staff on both sides of the
aisle of the House Energy and Commerce Committee and shared my view
that if there was any part of Enron's energy assets that had the
potential for abuse, it was that company's domination of the ``mark-to-
market'' exchange.
The allegations that Enron may have manipulated forward markets are
troubling, and I encourage the Committee to pursue these further.
However, I am not aware of any way these issues could be linked to
PUHCA. For those who argue that this shows that the Enron collapse did
impact energy markets, I would respond that, if these allegations are
proven true, it appears to have affected them in a positive direction
for consumers.
Let's now look at the second story, what did not happen.
1. Enron was not working to build a multi-state Insull-like utility
empire
To the contrary, it was looking to sell Portland General. In fact,
Enron probably would not even have been in the regulated utility
business at the time of its collapse if PUHCA had not hampered its
efforts to exit that business.
Why? PUHCA artificially limits the number of potential buyers of
any utility to non-utilities and those utilities who can meet the law's
physical integration requirements. The physical integration requirement
demands that two utility systems must be capable of interconnection to
be legally combined under PUHCA. This is one of the core problems of
PUHCA. It serves as a barrier to entry and investment and results in
market concentration.
This arcane and counterproductive requirement also limits
California's options as the state considers how best to recapitalize
its utilities.
2. Enron did not lobby for PUHCA repeal
It was a leading opponent of stand-alone PUHCA legislation and
testified before Congress that it would only support PUHCA repeal as a
trade-off for concessions it wanted.
Enron's overall policy position with regard to traditional
utilities can perhaps best be described as disqualify and dominate:
Work to keep asset-backed utilities out of emerging energy markets,
then dominate those markets.
The Committee should also be aware that in its most recent
congressional testimony on electricity policy, Enron opposed enhanced
access to books and records, provisions that we have long favored.
On July 22, 1999, Enron's Executive Vice President Steven J. Kean
testified before the House Energy and Power Subcommittee, ``we have
concerns that H.R. 2363 creates unneeded regulatory oversight of
affiliated companies that have no need for additional regulation of
their books and records.''
Supporters of PUHCA modernization and reform want more competitors
in the marketplace, not fewer, and support giving federal and state
regulators more tools to protect consumers.
3. Enron did not receive special exemptions from PUHCA
Enron received two PUHCA exemptions from the SEC. Both were clear
cases under the law.
The first was a statutory exemption provided to more than 50 other
holding companies whose utility operations are primarily located in a
single state.
The second exemption concerned the question of whether a power
marketer should be considered a ``public utility'' under PUHCA. PUHCA
defines an ``integrated public-utility system'' as, ``a system
consisting of one or more units of generating plants and/or
transmission lines and/or distributing facilities, whose utility
assets, whether owned by one or more electric utility companies, are
physically interconnected or capable of interconnection.''
The claim that the ``no action'' letter Enron received for Enron
Power Marketing Inc. constituted a special exemption for Enron that
ultimately allowed the company to escape regulatory scrutiny is the
entire basis for the claim before the Committee today. However, for the
SEC to have found otherwise would have required it to find that the
assets of marketers--office equipment, paper contracts, and computer
data--are ``facilities'' of public utilities comparable to generating
plants and transmission lines.
This raises the interesting question of how these types of
``facilities'' could meet PUHCA's ``physical integration'' requirement.
Obviously, they could not, and no other decision by the SEC seems
supportable under either the facts or the clear definition in the law.
More importantly, had the SEC decided otherwise, the entire power
marketing industry would probably not have developed.
It's hard to think of any single decision that would have had a
more negative impact on consumers and competitive wholesale markets.
4. What about the other exemption mentioned in the New York Times?
This exemption, to the Investment Company Act of 1940--not PUHCA--
is the exemption that some have claimed allowed Enron to engage is some
activities that played a significant role in the company's collapse.
This appears to raise some genuine issues--but these issues have
nothing to do with PUHCA, and attempts to use the Investment Company
Act exemption as a way to derail electricity modernization are clearly
opportunistic.
5. But couldn't the Enron collapse have been prevented had Enron
somehow been subjected to PUHCA?
Since it's clear Enron should not have been considered a registered
holding company, this could only be true to the extent that Congress
would apply PUHCA-like financial regulations to every other publicly-
traded company, energy or non-energy. There is nothing unique about the
energy industry concerning Enron's financial activities.
If, as has been reported, a company is willing to risk violating
the '33 and '34 Securities Acts, shred congressionally requested
documents, engage in highly questionable accounting practices,
knowingly mislead investors, and ultimately drive itself into
bankruptcy, why would we believe that PUHCA would somehow protect its
shareholders.
Congress can and should conduct a thorough review of all the
accounting, bookkeeping, pension and corporate governance issues raised
by this scandal. In some cases, laws and regulations may need to be
strengthened. But these changes should be applied to all publicly-
traded companies, not to a small subset of companies in one industry.
FERC Chairman Wood is moving aggressively to bring the wholesale
electric energy market to an end-state of transparency and vibrant
competition. Some are concerned that he is moving too quickly; others
may believe he is moving too slowly. Few would disagree with his goal
of achieving that end-state or the benefits that consumers will gain
when we get there.
In his testimony before the Committee last week, he said, ``If
Congress'' policy goal is to promote wholesale energy competition and
new infrastructure construction, then reform of the Public Utility
Holding Company Act of 1935 (PUHCA), supplemented with increased access
by the Commission to the books and state regulators to certain books
and records, will help energy consumers. Energy markets have changed
dramatically since enactment of PUHCA, and competition, where it
exists, is often a more effective constraint on energy prices. In the
65 years since PUHCA was enacted, much greater state and federal
regulation of utilities and greater competition have diminished any
contribution PUHCA may make toward protecting the interests of utility
consumers.''
This is not just the view of Chairman Wood, but also all the
members of the Commission, and all his predecessors in the last decade.
They have understood that this market will never achieve the depth,
transparency and level of competition we all seek if PUHCA's barriers
to entry and investment remain in place. The reasons why you must
eliminate the anti-competitive and anti-consumer aspects of PUHCA are
simple:
PUHCA's arbitrary limitations hurt consumers. Just last month, The
D.C. Circuit Court of Appeals remanded the SEC's approval of a large
utility merger that would provide consumers and the companies involved
more than $2 billion in savings, based solely on concerns related to
PUHCA's single region and physical integration requirements.
While some have claimed that this decision represented some form of
victory for consumer interests, I disagree. Quoting from the ruling,
the Court wrote, ``According to Petitioners, the Commission erred in
accepting (the two companies') projections that the proposed merger
would produce approximately $2.1 billion in cost savings. We disagree.
We owe considerable deference to the Commission's assertion that it
`reviewed the assumptions and methodologies that underlie' the
projections and found them `reasonable and consistent with . . .
precedent.' Moreover, Petitioners point to no evidence or expert
testimony supporting their assertion that the companies' calculations
were flawed.''
The law's ownership restrictions keep capital out of one of this
country's most critical industries at a time when needs in the
transmission sector alone will require tens of billions of dollars in
new investment. As I mentioned before, Mr. Buffett has publicly stated
his intent to invest as much as $15 billion in the industry if PUHCA is
repealed.
The law's counterproductive requirements of interconnection and
geographic proximity foster regional concentration, directly counter to
50 years of antitrust law. As I mentioned during testimony in the House
last year, one of the ironies of PUHCA is that the only other utility
that MidAmerican could purchase without running afoul of the Act are
the utility assets of the only other investor-owned utility in the
state.
As representatives of FERC have testified on numerous occasions,
PUHCA hinders their ability to establish large, multi-state regional
transmission organizations.
PUHCA also provides foreign companies which are not restricted by
the physical integration standard an advantage on their ``first bite''
entry into the U.S. market and, at the same time, sends overseas
American dollars that could be invested here. In view of the series of
negative events that have buffeted this sector beginning with the
crisis in California and the West, the overall economic downturn and
the negative financial impact of the Enron collapse on much of the
sector, I believe we could see a substantial increase in this trend in
the next several years.
Congress cannot fix PUHCA by tinkering around its edges. The
physical integration requirement and ownership limitations that are
it's main problems are embedded in the statute's core. You can,
however, replace PUHCA with enhanced books and records authority and
the other consumer protection measures recommended by Chairman Bingaman
and move the country forward toward a competitive, pro-consumer market.
The Chairman. Thank you very much.
Mr. Hempling, you are the cleanup witness here on this
panel. Go right ahead.
STATEMENT OF SCOTT HEMPLING, ATTORNEY AT LAW, SILVER SPRING, MD
Mr. Hempling. Thank you, Mr. Chairman and members of this
committee. My name is Scott Hempling. My law practice
represents many of those who are beneficiaries of the Public
Utility Holding Company Act, State commissions and consumers.
Repealing the act, without substituting modern regulatory tools
will leave those interests unprotected.
Repeal of the act, they say, in competition will flourish.
Let us examine this argument.
At the Federal level, in the summer of 2000, the electric
industry moved from the back pages of the business section to
the front pages of the main section. The California price hikes
that summer were the natural culmination of 20 years of
carelessness in the analysis of wholesale markets, in the
design of mechanisms to make those markets work, and in the
design of consumer protections for when those markets do not
work.
Consider the shifting rationales supporting FERC's foray
into market pricing since the late 1970's. First, the rationale
was to increase supplies. Then the rationale was to increase
performance and coordinating services. Then the rationale was
to compensate utilities for new risks. Then the rationale was
to stabilize the weaker companies. And then came two new
rationales: first, that energy pricing was justified by a
competitive market; and next, that market pricing was necessary
to attract entry into a non-competitive market. Notice the 180
degree turn in the last two rationales. Both cannot be correct.
Yet, for over 20 years, all of these rationales were accepted
by the Federal Energy Regulatory Commission.
To its credit, the present FERC is bringing these issues
forward openly and forthrightly. Recent issuances from the FERC
on market analysis and refunds reveal how significant were the
past errors and how difficult is the work ahead. But no one
knows how long it will take to make wholesale markets work.
Concerning regional transmission policy, core to the
competitiveness of wholesale markets, anyone not recently freed
from solitary confinement knows that, after 30 years of
discussion, almost every issue remains on the table:
independence for market participants, geographic scope and
configuration, operational authority, short-term liability
authority, tariff administration design, congestion management,
parallel path flow, ancillary services, market monitoring,
inter-regional coordination. While the present FERC has made
dramatic progress in the past 7 months, this FERC would be the
first to admit that the date on which all markets will be
served by RTO's that are independently governed, efficiently
priced, reliably operated, and publicly accountable is known by
no one. In both these areas, market pricing and transmission,
the present FERC is grappling with the problems and alternative
solutions, but no one objective can credibly pinpoint the date
on which these defects will disappear.
On multistate mergers, the industry consolidation is
accelerating, but FERC merger policy has failed to hold mergers
to the efficiency tests which would be required in a
competitive market. Specifically, the FERC does not compare a
proposed merger to alternative outlets for investment. It does
not, in comparing costs and benefits, take into account
acquisition costs, but instead focuses only on implementation
costs and accounts as benefits coordination savings which could
be obtained without a merger. That's at the FERC level.
At the State level, significant barriers to wholesale
competition remain. Utilities are still retail monopolies
almost everywhere. Retail ratemaking, using techniques in place
for most of the last century, still induces utilities to favor
the rate-basing of their own plants rather than buying on the
wholesale market, and there is a market trend toward
questioning construction at the State level by independent,
out-of-state entrepreneurs. Even perfect Federal policies
cannot create wholesale competition when State policies
discourage wholesale competitors.
These facts should not surprise us because for most of this
century the Government has given to a select set of
corporations exclusive control over some of the Nation's most
important assets, facilities for the generation, transmission,
and distribution of electricity. So, despite the talk of
competition, most utilities retain exclusive franchises to sell
at retail, plus control of the transmission highways, plus
influence over who will compete to sell generation in their
service territories, plus influence over who will compete to
provide demand site management services, still plus the right
to sell generation to other service territories inside and
outside the United States.
Our electric utilities have what economists call market
power, the power to prevent competitive markets from working.
The Public Utility Holding Company Act is a statute about
market power. Repealing the statute, without addressing the
problem of market power, is contrary to competition.
Let us now look more closely at some of the arguments for
repeal. The Holding Company Act addressed mergers with a simple
rule: only those mergers justified by improvement in physical
operations would be permitted and then only if those mergers
did not cause concentration of control or produce a complex
capital structure or otherwise harm the public interest. So, in
1935, the Congress blocked all non-integrating acquisitions
because it saw no possible benefit from them. Neither wholesale
competition nor retail competition was evident at the time.
Today we want more wholesale competitors, so there is a
legitimate question about the value today of the Holding
Company Act's prohibition on non-integrating acquisitions. And
in 1992, in the Energy Policy Act, Congress eliminated the
prohibition for wholesale generators.
That brings us to the question of retail competition. In
those States where retail competition is legally authorized, it
is true today that the Holding Company Act's prohibition on
non-integrating acquisitions limits the number of players in
that market to those whose physical operations are integrated
with that market. A retail customer shopping there would be
better served with more players. Thus, the question whether to
relax the Holding Company Act's ban on non-integrating
acquisitions in this specific context is worth considering, and
the legislative treatment I explain in my testimony makes room
for such an adjustment.
But this reasoning does not apply at all in a retail market
for which competition has not been authorized. In that non-
competitive context, the Holding Company Act presents a barrier
not to competitive entry but to monopolistic acquisition. That
distinction deserves emphasis. There is a significant
difference between financial entry and competitive entry. The
acquisition by one monopolist by another is a change in
control, not an increase in competition. To call this entry and
then to criticize the Holding Company Act because it blocks
market entry is to misuse the term. It is entry into a new
market from the perspective of the acquirer seeking new captive
customers, but it is not a new competitive entrant from the
perspective of those captive customers for the simple reason
that there is no competition.
Turning to S. 1766, the central themes of the Holding
Company Act remain relevant today: preventing utility
acquisitions that are not justified by efficiencies, limiting
speculative investments, prohibiting inter-affiliate
transactions, and restricting unsound practices. Therefore,
acquisitions need to be continued on findings that they are the
product of a competitive market, that they produce measurable,
guaranteed benefits for the ratepayers of both the acquirer and
the acquiree, that they do not weaken the financial strength of
either the acquirer or the acquiree, and that they do not
deprive existing utility customers of the benefits associated
with their past contributions.
Title II of S. 1766 makes important contributions by
clarifying the FERC's jurisdiction over mergers and by
emphasizing care in the granting of sellers the right to charge
market-based rates. But with the repeal of the Holding Company
Act, the commission will need more substantial affirmative
authority so as to screen in those acquisitions which promote
efficiency and competition and screen out those acquisitions
which do not.
Congress should transfer the regulatory responsibilities
concerning the Holding Company Act to FERC. There seems to be
consensus on that subject, for while FERC has not always
pleased all its constituents and while it has used
methodologies for merger review and market pricing that are
disconnected from economic logic, it has remained publicly
committed to the Federal Power Act.
The Public Utility Holding Company Act has not enjoyed
comparable respect. 20 years ago, the SEC took the position
that the act no longer was necessary because regulators could
protect the consumer, and the agency held to this position
firmly, right through the era of nuclear cost overruns, right
through the era of savings and loan failures, through the era
of the bankruptcies of three multi-billion dollar utilities,
right through to 1996 when FERC officially discovered, 2
decades later than everyone else, that transmission owners
exercised market power in generation markets, and even through
the California market failure, that transferred billions of
dollars from customers to generators.
Now the rationale has shifted. If regulators do not protect
the consumer, competition will. Yet FERC, the very agency to
which the SEC claims to defer, acknowledges the difficulties in
implementing competition.
A world without the Holding Company Act. What would it look
like? Without the Holding Company Act or its modern
replacement, we would have a world of unreviewed acquisitions
of retail monopolies, unlimited mixing of businesses which
serve captive customers businesses, which take their risks into
competitive markets, and no advanced reviews of the prudence of
securities issuances. All this would take place in a world in
which most retail customers have no competitive choices and in
which the Nation's chief electric regulator acknowledges that
wholesale competition is a work in progress.
We can do much better. We can relax the integration
requirement, as other witnesses have pointed out. We can put
limits on diversification, but allow it upon a showing of
customer benefit and competitive improvement. And we can
establish clear obligations in FERC to apply economic
efficiency and competitive market standards to mergers.
That brings me to Warren Buffett who wants to enter the
industry. He is more than welcome. He can come in as an exempt
wholesale generator under the Energy Policy Act. He can buy an
unlimited number of generation companies anywhere in the
country without review. He can come in as a retail marketer or
broker under rule 58 of the SEC. He cannot come in at this time
and acquire existing monopoly assets. Let me emphasize. There
are three ways he can enter the industry. The first two ways,
he would be subject to what everybody argues is heated
competition. In the third way, he can come in as a monopolist.
Who would not complain about a statute that prevented him from
picking up monopoly assets and selling to customers who have no
choice but to buy his product? But even in this third way, Mr.
Buffett should not be denied. If he can show that his entry is
the product of competition, real competition, where he has to
fight tooth and nail to win the favor of the ratepayers that he
seeks to serve, then in my mind we should amend the Holding
Company Act to let him in.
In closing, the electric industry lacks effective
competition in many markets. Congress cannot nurture
competition by giving free rein to companies which for a
century have avoided competition, and Congress cannot protect
consumers by confusing financial entry with competitive entry.
To repeal the Holding Company Act without establishing a modern
regulatory regime, one that conditions acquisitions on real
competition and attentive regulation, is to allow dominant
incumbents to exploit unearned advantages. Calling the result
competition is good fiction but it is not good policy.
Thank you for the opportunity to present this testimony. I
look forward to your questions.
[The prepared statement of Mr. Hempling follows:]
Prepared Statement of Scott Hempling, Attorney at Law,
Silver Spring, MD
Mr. Chairman and Members of the Committee:
My name is Scott Hempling. I am the principal in a law firm which
advises public and private sector clients involved in regulated
industries, particularly state regulatory commissions and organizations
of consumers or consumer representatives. I have represented clients in
many cases under the Public Utility Holding Company Act of 1935
(PUHCA), before the Securities and Exchange Commission (SEC) and the
U.S. Court of Appeals. I have testified before this and other
Congressional committees many times on PUHCA and other electric
industry matters. My testimony today reflects my own views, and not
necessarily those of any past or current client.
I. INTRODUCTION: IS COMPETITION HERE?
Proponents of PUHCA repeal assert that ``competition is here,'' or,
that competition will be here once the Act is gone. These statements
suffer from a lack of precision. Competition remains elusive, and those
seeking to implement it struggle with a long list of unresolved issues,
at both the FERC and state levels.
A. Competition Remains Elusive
For most of the last century, the combined actions of federal and
state policymakers have given a selected set of companies the exclusive
power to own the strategic assets of the electric industry: generation,
transmission and distribution.
In two major efforts, Congress tried to stimulate a substantial
nonutility presence in the generation sector. The Public Utility
Regulatory Policies Act of 1978, and the Energy Policy Act of 1992,
created categories of wholesale generating companies that would avoid
``electric utility'' status under PUHCA. Avoiding PUHCA meant that
anyone could acquire any number of these generating companies in any
location, using any corporate structure, unaffected by the various
PUHCA requirements.\1\ The PUHCA repeal sought today, in the name of
competition, was largely granted in 1978 and 1992 for the wholesale
generating sector.
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\1\ The exception is the limit on the share of a PURPA ``qualifying
facility'' that can be owned by a utility.
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PUHCA repeal at wholesale has not brought effective competition at
wholesale. Despite some inroads by independent companies, most
generation remains concentrated in traditional utilities or their
affiliates. As discussed in Part I.B and C. below, we face a long
struggle before electric generation looks like the competitive
commodity markets that characterize wheat, soybean and pork bellies.
In the meantime, those who control generation are exploiting their
advantages. Mergers of utilities with market power have become almost
routine. These efforts at ``strategic positioning'' might be benign in
a competitive environment. But in an industry infected with market
power in every major asset and service segment, these mergers are
biasing markets against competition for years to come.
Under these conditions, the repeal of PUHCA, on a stand-alone
basis, can only make matters worse. Freeing dominant incumbents to
acquire others may improve their own standing, but it will not improve
the electric industry. It will burden further our regulators, and the
customers they try to protect.
As discussed in Part I.B below, the Federal Power Act, in its
design by Congress in 1935 and in its implementation by the Federal
Energy Regulatory Commission (FERC) today, has serious gaps. Meanwhile,
state regulators are striving to keep up with today's changes. But
state regulation was a tool designed primarily to regulate local
utilities and local transactions. The number and complexity of
multistate transactions today pose real difficulties for State
regulation. Many state commission staffs are struggling with the
burdens of rate cases, intervention in FERC proceedings concerning
mergers and transmission access, as well as the numerous changes in the
gas and telecommunications industries.
B. The Implementation Struggle at FERC
On three key issues--measuring competitiveness, regional
transmission service and mergers--the industry and its regulators lack
a common understanding and commitment.
1. Measuring Competitiveness
The California price spikes of 2000 were the natural culmination of
20 years of carelessness in the (a) analysis of wholesale markets, (b)
design of mechanisms to make those markets work and (c) design of
consumer protections for when those markets do not work.
Consider the shifting rationales supporting FERC's departure from
cost-based ratemaking since the late 1970's:
--desire to increase supplies
--increase performance in coordination services
--desire to compensate for new risks
--financial stabilization of weaker companies
--market pricing is justified by a competitive market
--market pricing is necessary to attract entry into a
noncompetitive market
The sixth rationale was offered by many generators during the
California summer and repeated by the then-FERC Chairman. Notice the
180 degree turn from the preceding rationale. Only one of those
rationales can be lawful. Yet both rationales, and most others
rationales offered by applicants over the past 20 years, were accepted
by the Commission, although not without dissent.
To its credit, the present FERC is bringing these issues forward,
openly and forthrightly. Recent issuances on market analysis and
refunds reveal how significant were the past errors and how difficult
is the work ahead.
a. Recent Actions on Market Measurement
There finally has been official recognition of the illogic plaguing
the ``hub and spoke'' and ``delivered price test'' approaches to market
measurement, and the need to replace them. On the subject of ``hub and
spokes'' method, FERC itself has explained its deficiencies:
An accurate assessment of the effect on markets depends on an
accurate definition of the markets at issue. The Commission's
current analytic [hub-and-spoke] approach defines geographic
markets in a manner that does not always reflect accurately the
economic and physical ability of potential suppliers to access
buyers in the market. . . .
A drawback of this method of defining geographic markets is
that it does not account for the range of parameters that
affect the scope of trade: relative generation prices,
transmission prices, losses, and transmission constraints.
Taking these factors into account, markets could be broader or
narrower than the first- or second-tier entities identified
under the hub-and-spoke analysis. . . .
Another concern with the [hub-and-spoke] approach . . . is
its analytic inconsistency. It defines the scope of the market
to include the directly interconnected utilities that are
accessible due to the applicants' open access tariff, but does
not expand the market to recognize the access afforded by other
utilities' tariffs. This was acceptable before open access was
established as an industry-wide requirement for public
utilities.
Merger Policy Statement, Docket No. RM96-6-000, 61 Fed. Reg. 68595 at
68599 (Dec. 30, 1996) (emphasis added).
Yet FERC, until about two months ago (about five years after
acknowledging its serious defects), continued to apply the ``hub and
spoke'' test to all applications for market-based pricing.
Then, on November 20, 2001, FERC came to terms with the fact that
market-based rates had been approved for entities able to exercise
market power. AEP Power Marketing, Inc., 97 F.E.R.C. para. 61,219 (Nov.
20, 2001) (order on triennial market power updates and announcing new,
interim generation market power screen and mitigation policy). That day
the Commission issued an order replacing its ``hub and spokes'' test
for market pricing with a new interim test called the Supply Margin
Assessment (SMA). The Commission stated that it had concluded that,
``because of significant structural changes and corporate realignments
that have occurred and continue to occur in the electric industry, our
hub-and-spoke analysis no longer adequately protects customers against
generation market power in all circumstances.''
Under the SMA, FERC will ask whether the applicant for market
pricing has an amount of capacity which exceeds the supply margin
(excess of supply over peak demand) in the prospective buyer's control
area, taking into account transmission constraints. Where it finds that
the seller controls supply resources exceeding the supply margin, FERC
will conclude that the applicant seller is in a position to exercise
market power and may limit the buyer to a ``split savings'' price
rather than a market price.
FERC's November 20 order applied the new test in pending cases for
renewal of market rate authority involving American Electric Power Co.,
Entergy Corp. and the Southern Cos. Within the control areas of each of
the companies, the Commission found that the companies could exercise
market power ``because [their] generation is needed to meet the
market's peak demand.'' The Commission therefore imposed mitigation
measures.
b. Recent Actions on Refunds
Only in the last two months has the Commission moved to establish
an express refund mechanism that protects consumers from market rates
which, while perhaps just and reasonable at the time they were
authorized, might become unjust and unreasonable later due to a decline
in competitive forces. See Investigation of Terms and Conditions of
Public Utility Market-Based Rate Authorizations, 97 F.E.R.C. para.
61,220 (Nov. 20, 2001) (order establishing refund effective date and
proposing to revise market-based rate tariffs and authorizations). The
proposed order would amend all market rate tariffs to clarify that
where FERC finds that a seller with market rate authority has acted
anti-competitively, FERC may issue a refund order. The order indicates
that in ordering refunds the Commission will focus on two types of
anti-competitive behavior--physical or economic withholding of
supplies.
In short, the present FERC is struggling, openly and determinedly,
to solve, on many fronts at once, a set of problems that has smoldered
for years. But this very struggle is cause for caution. As hardworking
and determined as they are, the present FERC Commissioners, like any
prudent regulators, likely would hesitate to name a date on which they
expect to see effective competition in all wholesale markets.
2. Regional Transmission Service
As to regional transmission policy, anyone not recently freed from
solitary confinement knows that after 30 years of discussion almost
every issue remains on the table:
--Independence from market participants
--Geographic scope and configuration
--Operational authority
--Short-term reliability authority
--Tariff administration and design
--Congestion management
--Parallel path flow
--Ancillary services
--Market monitoring
--Transmission planning and expansion
--Interregional coordination
While the present FERC has made major progress in the past 7
months, this FERC would be the first to admit that the date on which
all markets will be served by RTOs that are independently governed,
efficiently priced, reliably operated and publicly accountable is known
by no one.
3. Mergers
Under Section 203 of the Federal Power Act, the FERC must
disapprove mergers that are not consistent with the public interest. 16
U.S.C. 824b. Beginning in 1985, a process of consolidation began and
accelerated in the second half of the 1990s. Mergers are now routine;
yet there has been neither consensus nor clarity concerning FERC's
merger analysis. Merger review at FERC remains economically
indefensible. This conclusion follows from four merger principles that
have emerged from various FERC cases:
a. The public interest is protected if costs do not exceed
benefits, even though there might be other mergers or other
investments which can produce the same benefits at a lower
cost.
b. In comparing costs to benefits, FERC disregards
acquisition cost and counts only implementation cost.\2\
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\2\ One would not buy a rental property merely because the expected
rent exceeded the costs necessary to rehabilitate and maintain the
space for tenants. One would buy the property only if the expected rent
exceeded these implementation costs plus the acquisition cost.
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c. The FERC counts as ``benefits'' coordination savings which
could be obtained without a merger.
d. The FERC counts as ``benefits'' elimination of pre-merger
imprudence.
Put simply, the present merger review standards do not distinguish
efficient mergers from inefficient mergers. In a competitive market, a
merging partner employing this analytical casualness would lose its
shirt; in a regulated monopoly setting, the shirts are the customers'.
This policy, applied repeatedly for 16 years, has done long-term damage
to the cause of competition. There remains no process, either
competitive or regulatory, that distinguishes combinations based on
efficiency from combinations based on market share maintenance or
market dominance.
C. The Implementation Struggle at the State Level
The problem of wholesale competition is not FERC's alone. The most
pro-competitive FERC policies will not produce wholesale competition if
entry is blocked in other ways. Several clouds appear, not only on the
horizon but directly overhead:
1. Accommodating utility preference for self-construction: Few
states have policies mandating that retail utility monopolies purchase
their needs on the wholesale market. Leaving the choice with the
vertically integrated utility creates strong bias favoring vertical
integration and disfavoring wholesale competition.
Only occasionally is it in a utility's interest to forego
construction (which would add to its rate base and therefore add to its
profit), in favor of purchasing power from others (which assigns the
profit to the generator and makes the utility a mere cost conduit).
2. State concerns with independent generation: Most states work
mightily to attract physical investment: investment which creates jobs,
broadens the tax base and, in the case of exporting industries,
increases the state's trade surplus. In the case of new non-utility
generation, this practice does not seem to exist; in fact the trend is
in the opposite direction. An increasing number of states are
questioning the benefits of allowing generation construction by
companies that do not have firm loads, or who have customers located
outside the state. In some instances, legal and political opposition to
such construction has come from the incumbent utilities, who do not
want competitors to gain a beachhead in their home markets. In other
instances, there is legitimate concern from citizens wishing to avoid
excess construction. Some seek to limit construction of generation in a
state to plants intending to serve load in that state, even though such
``hoarding'' of in-state benefits and obstruction of interstate trade
is a per se violation of the Commerce Clause of the U.S. Constitution.
See New England Power Co. v. New Hampshire, 455 U.S. 31 (1982)
(invalidating state law, which preserved benefits of state
hydroelectric power for in-state consumers, because the law was
``designed to gain an economic advantage to in-state consumers'' to the
detriment of consumers out of state).
The opposition to new generation, whether strategic or citizen-
based, legitimate or illegitimate, has similar effect: it discourages
competitive entry.
These two examples--utility preference for utility construction and
state concerns with independent generation--indicate that the interest
in wholesale competition has limits, when the costs of that competition
are felt close to home, or when the losing competitor might be the home
team. The best RTO policies in the world will not bring us wholesale
competition, if state policies obstruct new generators. RTOs without
generation entry means highways without traffic.
D. Overview of this Testimony
The central facts discussed above--that competition remains elusive
and that its success depends on FERC and the states getting dozens of
decisions right--establish the proper context in which to consider
change to PUHCA. This testimony does not argue against any change to
PUHCA. Instead, it describes the conditions which must be in place
before amendment or repeal, so that persistent market power does not
harm the consumer or impede progress to effective competition.
This testimony has five remaining sections.
Part II describes how PUHCA's major themes remain relevant today.
Part III recommends that Congress modernize certain PUHCA
protections, and transfer the regulatory responsibility to FERC.
Part IV shows the how the arguments for stand-alone repeal lack a
factual basis.
Part V underscores the continuing relevance of PUHCA, and the need
for a federal corporate structure statute, by explaining that proper
application of PUHCA would have identified and prevented Enron's ill-
fated activities.
Part VI concludes this testimony by describing the consequences of
a world without a federal corporate structure statute for the electric
industry.
II. PUHCA'S MAJOR THEMES REMAIN RELEVANT TODAY
Congress passed PUHCA to protect the public, investors, and
consumers from utility holding company abuses. Congress identified
several categories of abuses and acted comprehensively to address them.
Today we still have the risk of abuse, and we still have the public,
investors and consumers to protect from abuse. Most of the themes of
the Act remain relevant today, including:
a. Prevent acquisitions that are not justified by operational
efficiencies
b. End abusive inter-affiliate transactions
c. Restrict unsound financial practices
I discuss these main themes next. For each of the three themes, I
will explain the original purpose, describe how the statute addresses
it and show that the original purpose remains necessary.
A. Prevent Acquisitions Unrelated to Operational Efficiencies
Original Purpose: Congress was concerned about acquisitions
motivated by acquisitiveness rather than operational efficiencies.
These acquisitions produced complex holding companies structures aimed
at milking the individual utilities and their customers, using
techniques that state regulators could not police. Congress concluded
that such holding company ``activities extending over many States are
not susceptible of effective control by any State and make difficult,
if not impossible, effective State regulation of public-utility
companies.'' Section 1(a). Congress saw a need to require holding
companies to maintain a focus on the core business of utility service
to captive consumers, limit financial risks to ratepayers, and protect
businesses in unregulated industries from anti-competitive cross-
subsidies.
Tools: Review of Utility Acquisitions: Congress adopted geographic
restrictions on the growth and extension of holding companies by
precluding utility holding company acquisitions where the acquired
utility is not physically integrated (the ``integration'' requirement)
and coordinated with existing utility properties. Section 2(a)(29)(A).
Congress further required that utility acquisitions create new
operational and managerial efficiencies. Acquisitions under the Act
must therefore create positive operational benefits. Section 10(c)(2).
Congress prohibited acquisitions of utility assets where the
acquisition will ``tend towards interlocking relations or the
concentration of control of public-utility companies, of a kind or to
an extent detrimental to the public interest or the interest of
investors or consumers.'' Section 10(b)(1).
Congress restricted registered holding companies to engaging in
businesses ``reasonably incidental, or appropriate to the operations''
of the public utilities. Section 11(b)(1).
Non-registered or ``exempt'' holding companies may diversify into
other businesses only to the extent that such diversification is not
``detrimental to the public interest, or the interest of investors or
consumers.'' Section 3(a).
Current Relevance: In most states retail electric and gas customers
remain unable to shop. They are no less captive today than they were in
1935. Even in states where retail competition has been adopted,
effective competition is largely absent. At the same time, the
industry, after several decades of quiet following breakups mandated by
PUHCA, has regained much of its pre-1935 concentration and complexity.
Many holding companies have dozens of affiliates, many of them making
investments worldwide. This growth in affiliates has had little to do
with improving service to customers.
B. End Unreasonable or Abusive Inter-affiliate Transactions
Original Purpose: Utility holding companies exploited utility
operating companies through financial mismanagement, taking advantage
of the inability of state regulators to analyze complex and multistate
transactions.
Tools: Review of Inter-affiliate Transactions: Congress sought to
ensure that holding companies could not use service, management,
construction, and other contracts to allocate charges among
subsidiaries in different states so as to obstruct effective state
regulation. In Section 13 Congress prohibited registered holding
companies from entering into contracts for services and goods (other
than power, which is regulated by FERC) without SEC approval.
In Section 12, Congress placed strict limits, and in some cases
outright bans, on certain financial transactions between utilities,
their holding companies and other subsidiaries. For example, a
registered holding company cannot borrow from its subsidiary utilities.
Sec. 12(a). Other limitations apply to a holding company's loans to its
subsidiaries and payments of dividends. All transactions are covered by
Commission rules concerning fair accounting treatment, maintenance of
competitive conditions, disclosure of interests, and other ``public
interest'' factors. Sec. 12(f).
Current Relevance: Industry consolidation, combined with an
increase in use of ``service'' companies that provide non-power goods
and services to the various utility operating companies of a holding
company system, means that consumers continue to be at risk from their
jurisdictional utility's transactions with affiliates. State regulators
do not have the ability and resources, and in some cases may lack
authority, to review the many transactions between affiliates of
utility holding companies. Further, without federal intervention state
regulators may be unable to access the books and records necessary to
review the costs of an inter-affiliate transaction.
C. Restrict Unsound Financial Practices
Original Purpose: Congress in 1935 found public harm from
speculative and unsound securities issuances. Prior to the Act, holding
companies issued securities based on inflated capital structures,
fictitious or unsound asset values, pyramidal structures, and other
market manipulations. Congress thus intended PUHCA to address the
adverse consequences to the public ``when . . . securities are issued
upon the basis of fictitious or unsound asset values having no fair
relation to the sums invested in or the earning capacity of the
properties and upon the basis of paper profits from inter-company
transactions, or in anticipation of excessive revenues from subsidiary
public-utility companies.'' Section 1(b)(1).
Tools: Review of Financing: Without SEC approval, a registered
holding company or its subsidiary may not issue or sell any stock, or
exercise any privilege or right to alter the priorities, preferences,
voting power, or other rights of the holders of an outstanding security
of the company. Sec. 6(a). (There are various exceptions, including for
private offerings, short-term securities, and others.)
In reviewing a holding company or its subsidiary's filing for
approval, the SEC must ensure, under Sec. 7(d), that:
issuance or sale of the security does not jeopardize the
security structure of the holding company system;
the security is reasonably adapted to the issuer's earning
power;
the type of financing is necessary or appropriate to the
economical and efficient operation of the issuer's business;
the fees and commissions paid are reasonable;
where the security is a guaranty of, or assumption of
liability on, a security of another company, the declarant is
not taking an improper risk; and
the terms and conditions of the issuance or sale are not
detrimental to the public interest or the interest of investors
or consumers.
If a State informs the SEC that State laws applicable to the
transaction have not been complied with, SEC must reject the
transaction. (Section 6(g)).
For utility acquisitions, the SEC must find that the amount paid
bears a fair relation to the sums invested in, and earning capacity of,
the underlying utility assets. (Section 10(b)(2)).
Relevance of Financing in the Current Industry Structure: As the
Enron events demonstrate, federal disclosure statutes do not prevent a
holding company or its subsidiaries from undertaking securities
transactions which conceal the underlying value of the company. PUHCA's
financial reviews do more than disclose; they apply a reasonableness
test to assure that financial commitments are commensurate with utility
service needs.
III. CONGRESS SHOULD MODERNIZE CERTAIN PUHCA PROTECTIONS, AND TRANSFER
THE REGULATORY RESPONSIBILITIES TO FERC
Although PUHCA's main themes remain relevant, the statutory devices
do not fit the industry today as well as they did in 1935. Some of
these devices can be eliminated, while others must be modernized. This
section describes the challenges posed by utility restructuring today,
and then presents prerequisites for PUHCA repeal, including conditions
on mergers and acquisitions, and on the mixing of utility and non-
utility businesses. I then argue that Congress should transfer
responsibility for the modernized protections from the SEC to FERC.
Finally, I analyze the provisions of Title 2 of S. 1766.
A. The Challenge of Utility Restructuring Today
Mergers between monopolies are different from mergers in
competitive industries. Competitive industries lack captive customers.
Customers ill-served by an expensive merger can shop elsewhere.
Customers of a regulated monopoly have no choice.
PUHCA addressed mergers with a bold stroke: only those mergers
justified by improvement in physical operations would be permitted, and
then only if those mergers did not cause a concentration of control,
produce a complex capital structure or otherwise harm the public
interest. See Section 10 of PUHCA. The effect of Section 10 was to
block acquisitions or mergers involving companies that could not,
because of physical separation, coordinate their electric operations
after the merger.
The 1935 Congress blocked all non-integrating acquisitions because
it saw no possible benefit from them. Neither wholesale competition nor
retail competition was evident at the time. Today, we have a policy of
promoting wholesale competition and, in some states, retail
competition. Competition works best if there is a substantial number of
entrants in each market. Especially when a market is dominated by the
incumbent as many present markets are, a marked increase in the number
of viable competitors is a prerequisite for real competition.
This need for new viable competitors raises a legitimate question
about the value today of PUHCA's prohibition on non-integrated
acquisitions. It is fair to say that until 1992, PUHCA's prohibition,
if enforced, limited the number of new competitors in any market to
those entities that operate physically only in that market. In 1992,
Congress, intending to promote wholesale competition, removed this
prohibition if the acquired company was an ``exempt wholesale
generator,'' that is, a company that owned a generator, which company's
exclusive business was the sale of electricity at wholesale. Thus, with
respect to wholesale competition, PUHCA does not present any
prohibition on entry, and has not for almost 10 years. Utilities and
non-utilities own many wholesale generation companies throughout the
nation, on a non-integrated basis.
That brings us to the question of retail competition. In those
states where retail competition is legally authorized, PUHCA's
prohibition on non-integrating acquisitions normally would limit the
number of players in that market to those whose physical operations are
integrated with that market. However, in 1997 the SEC promulgated Rule
58, 17 C.F.R. 250.58. Rule 58 allows registered holding companies to
create or acquire retail electricity marketing and brokering companies
as well as other energy-related companies, provided these companies do
not own utility assets and provided the aggregate investment in such
energy-related companies does not exceed the greater of $50 million or
15% of the consolidated capitalization of the registered holding
company. Thus, market entry at retail already is accommodated by SEC
rule. What is not accommodated is the non-integrated acquisition of
utility assets. Such acquisition could not increase competition where
the assets are monopoly assets, like transmission and distribution. In
that noncompetitive context, PUHCA presents a barrier not to
competitive entry, but to financial entry.
This distinction warrants emphasis. There is a dramatic difference
between financial entry and competitive entry. The acquisition of one
monopolist by another is a change in control, not an increase in
competition. To call this ``entry,'' and thus to criticize PUHCA
because it ``blocks market entry,'' is to misuse the term. It is
``entry into a new market'' from the perspective of the acquirer
seeking new captive customers. But it is not a ``new competitive
entrant'' from the perspective of those captive customers, for the
simple reason that there is no competition.
There is one circumstance under which the acquisition of distant
monopoly assets might benefit the public: when the acquisition is the
result of a competitive auction process designed to identify the most
efficient and innovative provider of monopoly services. For that
circumstance, some relaxation of the integration requirement is worth
considering, under the specific conditions discussed next.\3\
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\3\ In all acquisition situations, including those in this
subsection and the subsequent ones. the entity actually performing the
acquisition may be a utility or an affiliate of the utility. If there
is a utility with captive customers anywhere in the acquirer's
corporate structure, these principles should apply. Corporate form
should not create customer risk.
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Also, the regulator should be authorized to waive some or all of,
these prerequisites where the customers of the acquirer and acquiree
participate in markets subject to vigorous retail competition. In that
context, the protection can come from the market rather than
regulators.
B. Prerequisites for PUHCA Repeal
1. Conditions on Mergers and Acquisitions Involving
Utilities
The many PUHCA protections can be distilled into 5 modern
prerequisites to the approval of a merger or acquisition involving
utilities. Each is discussed next.
a. The acquisition must be the product of a competitive market; and
must not reduce the effectiveness of competition in the acquirer's or
acquiree's present or likely future markets.
The typical utility merger is not the product of real competitive
forces; it is the product of two companies, each with 100% market share
at retail, creating a combination which itself has 100% market share at
retail; and then persuading regulators to accept it. True competitive
market forces are not involved.
When the merging companies themselves, because of their retail
franchises, are not subject to strong competitive forces, there is only
one way for the merger itself to be the product of real competitive
forces: create competition for the monopoly franchise. The regulators
of the potential acquiree must host an auction, allowing multiple
companies to bid for the right to acquire. Only through this bidding
process can we identify the most efficient combination, the one most
likely to lower costs and increase quality.
This bidding process would reverse the economic positions of the
typical utility merger. In the typical utility merger, the acquiring
company bids for the acquiree's shareholders, paying the price they
demand. This process increases the cost of the merger to the acquirer.
That increased cost either causes ratepayers to pay higher rates, or
causes a decline in service quality due to the financial pressure. In
contrast, bidding for the franchise means bidding for the favor of the
ratepayers. That means the bidders are offering lower prices, better
services and more accountability, relative to the status quo. And that
is exactly what should happen in competition.
The requirement that the acquisition must be a product of a
competitive market also means that both the acquiree and the acquirer
should be subject to the maximum competitive forces allowed by law.
Assuming no retail competition, wholesale competition must be vigorous
in both the acquirer's and the acquiree's markets. Wholesale
competition will be vigorous only if there is a functioning,
independently governed regional transmission organization offering
efficiently priced transmission and ancillary services; low barriers to
entry for new generators and demand side management service companies;
and clear market mechanisms for demand side options.
b. The acquisition should produce measurable, guaranteed benefits
for ratepayers of both the acquirer and acquiree, by significantly
increasing the quality of service or decreasing the cost to consumers
of electric service.
Unlike an adjacent acquisition, which may produce operational
efficiencies from joint operations, a distant acquisition free of
PUHCA's integration requirement offers a less obvious ``upside'' to
existing ratepayers. The public does not benefit if the only reason or
effect of a merger is to increase the monopoly territory controlled by
a single company. If the acquirer can show that it will run the utility
better, then replacing one franchisee with another can benefit the
public. That standard applies in a competitive market; it is no less
appropriate in a retail monopoly context.
c. The acquisition should not weaken the financial strength of the
acquirer or acquiree.
Where an acquisition is motivated by acquisitiveness rather than
customer service, there can be a tendency to overpay for the merger
(that is, overcompensate the departing shareholders relative to the
real savings produced by the merger). The result is a financially
weakened company, less able to invest internally for innovation, and
more likely to seek government assistance in the form of rate
increases. The regulator therefore needs to assure that the purchase
price bears a reasonable relationship to the underlying costs and
benefits of the combination.
d. The acquirer should compensate its existing ratepayers, at a
market price, for the use of any resources which facilitate the
acquisition or assist the acquired business, to the extent such
ratepayers have borne the economic burdens associated with such
resources.
When acquiring a new company, a utility may use resources for which
ratepayers have paid. These resources might include valuable employees
and equipment. Although these assets are owned nominally by the
utility, the ratepayers have borne the associated economic risk, at
least where the cost of the asset has been included in rates even
though the market value of the asset might be lower. If the utility
were able to make use of these assets without compensating the
ratepayers at market value, the utility would be obtaining a reward
from assets for which ratepayers bore the risk. This mismatch of risk
and reward harms not only the existing ratepayers (by causing them to
bear costs without realizing benefits), but also the effectiveness of
competition (since the utility's competitors would not have had captive
ratepayers to bear the cost of the assets involved). Requiring the
utility to pay market price ensures that the utility is held to a
market standard.
e. The acquiring utility may recover its acquisition cost from its
existing utility customers, to the extent of tangible, measurable
savings created for those customers.
This commonsense financial management applies to traditional
utility investments, as well as in competitive markets. It prevents the
acquirer from paying an artificially high price and then recovering
that high price from ratepayers. It subjects the utility to the type of
cost discipline that is imposed by effective competition. Under
effective competition, the competitive market sets the price. An
acquirer can recover its acquisition premium only if its post-
acquisition costs are low enough to leave a margin with which to pay
off the premium.
2. Conditions on the Mixing of Utility and Non-Utility
Businesses
a. The Problem: With real retail competition almost nonexistent and
wholesale competition uneven, customers remain vulnerable to their
suppliers' business risks. Prominent among these risks is the risk of
non-utility diversification.
The business risks associated with utility diversification are
well-known. Utility holding company diversification has fared
poorly.\4\ Among the prominent examples was the failed investment by
Pinnacle West, the holding company for Arizona Public Service, in a
savings and loan institution. The failure resulted in Pinnacle West
having to borrow several hundred million dollars from insurance
companies to pay off bank depositors. As collateral for the loan,
Pinnacle West pledged its only significant asset: Arizona Public
Service.
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\4\ According to one commentator, the results were ``horrendous in
the aggregate and . . . satisfactory to disastrous for individual
utilities.'' C. Studness, ``Earnings From Utility Diversification
Ventures,'' Public Utility Fortnightly 28-29 (September 1, 1992).
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Absent regulatory review of diversification, utility management has
the incentive and opportunity to use ratepayer resources for
shareholder ends. In a competitive market, ratepayers can protect
themselves from such management decisions by shopping elsewhere. Absent
a competitive market, protection must come from a neutral regulator.
The other side of the coin, distinct from the ratepayer harm, is
the harm to competition in the industries entered by utilities or their
affiliates. Utilities (typically through unregulated affiliates or
subsidiaries) now routinely sell appliances; provide plumbing, heating,
and cooling equipment and service contracts; engage in insulation work
and sales of storm windows and doors; and provide outdoor lighting and
interior lighting fixtures. Utilities also have entered the real
estate, security and alarm monitoring markets, telecommunications, and
related energy markets such as energy management and energy monitoring.
Exacerbating the problem is the proliferation of multi-state
operations in which utility affiliates are engaged. Consider a holding
company system, based in State X, that operates mechanical and
electrical contracting affiliates in several other states. A non-
affiliated competitor based in State Y, and injured as a result of
cross-subsidization, may lack standing to file a complaint with the
commission in State X because he is not a ratepayer of the subsidizing
utility; meanwhile, his own state commission would not likely have
jurisdiction over a non-utility affiliate of an out-of-state utility.
Further, a public utility's monopoly franchise may impart an
ability and a legal right to gather customer site information regarding
energy use, including a complete profile of each customer with respect
to billing and credit history. Such information can be accessed or made
available to unregulated affiliates while being withheld from non-
affiliated competitors.
b. Solutions: The mixing of utility and non-utility business can
occur in one of two ways: a utility acquires a non-utility business, or
a non-utility business acquires a utility business. In each of these
contexts, the diversification should be subject to standard regulatory
techniques which anticipate and respond to the risks. Those techniques
fall into five categories:
(i) Advance Review: Advance federal review of financing where
effective State review does not exist, or where such review is
requested by a State commission.
(ii) Financing Requirements: Required use of non-recourse (i.e.,
non-recourse to the holding company or any affiliate other than the
affiliate undertaking the business) financing for all non-utility
investment, and a ban on inter-affiliate loans or guarantees from the
utility to the non-utility business. Non-utility businesses should pass
the market test: they should be financeable by the market on their own
merits.
(iii) Protections Against Excess Business Risks: To protect against
excess business risks, there should be caps on diversified investment,
and type-of-business and place-of-business reviews.
(iv) Protections Against Cross-Subsidies: A cross-subsidy occurs
when utility ratepayers incur costs which benefit the non-utility
affiliate, and the non-utility affiliate does not compensate the
utility adequately. The problem of cross-subsidy exists whenever a
single corporation, or corporate family, operates in monopoly and
competitive worlds.
--Where the utility purchases goods or services from its
affiliate, the proper compensation rule is ``the lower of
market or fully allocated book.''
--Where the utility sells goods or services to its affiliate,
the proper rule is market price.
(v) Access to Information: The regulators should have
access to books and records of the utility and all its
affiliates, to the extent such access is relevant to the
protection of ratepayers.
access to the books and records of any third party who is or
will become a joint venturer of the utility or any affiliate of
the utility, to the extent such access is relevant to the
protection of ratepayers.\5\
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\5\ As with the merger review standards, the regulator should be
authorized to waive some or all of these prerequisites where the
customers of the acquirer and acquiree are subject to vigorous retail
competition. In that context, the protection can come from the market
rather than regulators.
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3. Arguments Against Diversification Review
Some attack diversification review as ``anti-business.'' This
attack misperceives the purpose of regulation. The purpose is to assure
that diversified investment pays its own way, and succeeds or fails on
its merits, rather than by relying on ratepayer resources. This
principle aligns completely with economic efficiency and business
prudence.
Shareholders who view appropriate utility regulation as
inconsistent with their overall financial objectives can pursue those
objectives by investing in diversified enterprises separately from
their utility investment. They do not need the option of investing in
competitive businesses through their investment in the utility.
Some have argued that the diversification of a company's business
portfolio strengthens the company and therefore produces ratepayer
benefits. This reasoning misunderstands the nature of regulation.
Regulation permits a prudent regulated monopoly to earn a fair rate of
return. If a company is performing below par in its monopoly business,
the solution is to improve its performance, not seek solace in other
investments.
4. The Necessity for a Federal Role
Some have argued that PUHCA is no longer necessary--and needs no
modern federal replacement--because state regulators can protect
consumers. This argument fails for four real-world reasons.
a. Many states lack the authority to investigate the sources of
risk: the investment practices or financial condition of affiliates
which are not utilities or which are located out of state.
b. Some investment errors are too large to correct through
ratemaking disallowance, because that disallowance could place the
utility in financial jeopardy and endanger service.
c. A registered holding company can use its multistate status to
avoid effective regulation of inter-affiliate transactions. In Ohio
Power v. FERC, 954 F.2d 779 (D.C. Cir.), cert. denied, 113 S.Ct. 483
(1992), the Court of Appeals for the D.C. Circuit held, among other
things, that the FERC (and, by implication, States) could not disallow
from rates the costs incurred by Ohio Power, a utility subsidiary of a
registered holding company, in purchasing coal from its subsidiary,
even though the costs exceeded the market price.
The types and magnitude of inter-affiliate transactions are almost
unlimited. Most registered holding companies already have one or more
subsidiaries which provide goods and services to the utility
subsidiaries. These arrangements have included coal mines and other
fuel sources, computer services, billing, power supply planning, expert
witnesses, legal services, buildings and land. More recently, some
utility subsidiaries have transferred traditional functions--such as
nuclear plant operations--to these companies.
d. The multistate nature of electricity markets requires a
multistate review of the effect on competition. The policing of market
power is not a single-state task because the exercise of market power
is increasingly a multistate phenomenon. Market power obtained in one
State, even legitimately, can be leveraged into market power in another
State.
Moreover, in the acquisition by a multistate utility company of a
new utility--and almost all mergers are multistate there often are one
or more states lacking authority over the transaction. For example,
when CSW proposed to acquire El Paso, the transaction certainly would
have had an affect on the ratepayers of Arkansas, Mississippi and
Louisiana, but these states did not have proceedings. Similarly, when
Entergy acquired Gulf States, those states in which Gulf States did not
operate did not have proceedings. Although the acquisition by the
holding company serving Arkansas of a utility doing business elsewhere
certainly could affect Arkansas ratepayers, there was no state statute
making it clear that the Arkansas Commission would have jurisdiction to
review the transaction to protect Arkansas ratepayers.
C. Responsibility for the Modernized Protections Should Lie With the
FERC
1. The SEC's Staffing Situation
Although FERC has not always pleased all its constituents, and has
in the past used methodologies for merger review and market pricing not
based in economic logic (see Part I.B), it has remained publicly
committed to its statute.
The Public Utility Holding Company Act has not enjoyed comparable
respect. More than twenty years ago, the SEC took the position that the
Act no longer was necessary because markets and other regulators
protect the consumer and the investor. The agency has held to this
position through the era of nuclear cost overruns, the savings and loan
failures, the bankruptcies of several utilities, utility
diversification, the ``discovery'' that transmission owners exercised
market power in generation markets, and even through the California
price spike troubles of Summer 2000. Untroubled by the facts on the
ground, the SEC has held firm.
It is unclear which is the cause and which the effect. But roughly
contemporaneous with its repeal position has been a staffing
arrangement that is not commensurate with its statutory obligations. My
focus is not on work ethic or dedication, but on professional
expertise. Here are five concerns:
a. The analysis of large scale operational relationships
requires expertise in engineering. The SEC's PUHCA has no
engineers; it has had none for years.
b. The analysis of the competitive effect of mergers on the
many affected electric markets, both product markets and
geographic markets, demands expertise in economics at the
highest level. The SEC's PUHCA office has no economists; it has
had none for years.
c. The analysis of the risks associated with diversification
conducted by well over 100 utility holding companies demands
expertise in business management, including risk assessment,
business strategy assessment, and managerial organization and
effectiveness. The SEC's PUHCA office has no business
management specialists.
d. The review of inter-affiliate sales of goods and services
(Section 13) requires expertise in the pricing and procurement
of a host of products--fuels, accounting services, nuclear
operations services, real estate costs--literally any business
activity affecting the production of electric service. The
SEC's PUHCA office has no business procurement specialists.
e. The review of internal and external financial transactions
of over 15 multi-billion dollar registered holding company
systems, some with global operations, would strain even a large
staff. The SEC must review issuances of securities (Sections 6
and 7), inter-affiliate loans (Section 12), and capital
structure (Sections 10(b) and 11(b)). Literally thousands of
transactions occur involving billions of dollars. The SEC's
PUHCA office has one accountant.
2. The Statutory Application Problems
The SEC also has issued a series of opinions that vary dangerously
from the intent and language of the statute. The most prominent example
is the integration requirement.
The Act allows holding acquisitions of public utilities only if the
acquisition produces a single ``integrated public-utility system,'' see
Sections 11(b)(1) and 2(a)(29)(A); \6\ and only if the acquisition
``serves the public interest by tending towards the economical and
efficient development of an integrated public-utility system.'' Section
10(c)(2). As utilities have sought to expand their reach, the
Commission has left behind these principles and accommodated their
proposals. The Courts have sometimes upheld the Commission and other
times reversed it; but the trend is unmistakably towards consolidation
and away from the competition-protective and consumer-protective
features of the statute. Some examples follow.
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\6\ There are exceptions to the ``single system'' rule in Section
11(b)(1)(A), (B) and (C) not relevant here.
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In WPL Holdings, Inc., 40 S.E.C. 634 (1988) the SEC disregarded the
economical and efficient development test of Section 10(c)(2) when it
approved an addition of a corporate holding company where there was no
evidence of increased operational efficiencies resulting from the
acquisition. The court of appeals reversed. Wisconsin's Environmental
Decade v. S.E.C., 882 F.2d 523 (D.C. Cir. 1989) (finding that the SEC
decision ``plainly gives no effect to the express language of the
statute, which permits the SEC to approve acquisition of a utility only
when the Commission has found that the acquisition `tend[s] towards'
the economical and efficient development of an integrated system). The
Commission on remand found financial efficiencies.
Furthermore, in 1988 the Commission found that a utility holding
company's participation in power plant construction consortium met the
statutory requirement for integration despite the minimal interactions
the plant would have with the utility. Order Authorizing Acquisition of
Common Stock of New Electric Generating Company, Release No. 35-24566
(Jan. 28, 1988), aff'd Environmental Action v. S.E.C., 895 F.2d 1255
(9th Cir. 1990). The Commission concluded that the facilities would be
coordinated even though there was no certainty that the public utility
would purchase power from the plant being acquired. The SEC based its
Section 10(c)(2) finding that there would be new economies resulting
from the acquisition on the utility's apparent need for power several
years after the acquisition.
In WPL Holdings, Inc., 66 SEC Docket 2256 (Apr. 14, 1998), aff'd
Madison Gas and Electric Co. v. S.E.C., 168 F.3d 1337 (D.C. 1999), the
SEC approved under the integration standard the merger of several
utility holding companies with utilities operating in Wisconsin,
Minnesota, Iowa and Illinois. The commission found that the assets met
the statutory requirement of interconnection even though the Iowa and
Minnesota assets were separated from the Wisconsin and Illinois assets,
with the only connection being a 3-year contract for transmission
service and the companies' plan to build a transmission line in the
future. The progression of the SEC's effort to deprive the statutory
interconnection requirement of meaning is evident from a chronology of
its decisions prior to WPL Holdings.\7\
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\7\ Conectiv, Inc., Release Nos. 35-26832, 70-9069, 1998 SEC LEXIS
326, *29 (Feb. 25, 1998) (approving use of contractual rights to
transmission ``when the merging companies are members of a tight power
pool''); New Century Energies Inc., Holding Co. Act Release No. 35-
26748, 1997 SEC LEXIS 1583, *41-42 (Aug. 1, 1997)(approving under
interconnection standard a contract for transmission service pending
the planned construction of a physical tie within five years of the
merger); Unitil Corp., 50 S.E.C. 961, 1992 SEC LEXIS 1016 (April 24,
1992) (lines could be built to connect the facilities located eight
miles apart, but were unnecessary for coordination given the third-
party contractual arrangements); Northeast Utilities, 50 S.E.C. 427,
1990 SEC LEXIS 3898, *48 (Dec. 21, 1990) (finding integration
requirement satisfied where transmission contract was for at least ten
years, and where companies were located within highly integrated power
pool); Centerior Energy Corp., 49 S.E.C. 472, 1986 SEC LEXIS 1655, * 16
(April 29, 1986) (merger partners owned the transmission facilities as
tenants in common and the contract had ``no termination date and
remain[ed] in effect as long as the [generation facilities acquired]
are in existence); Electric Energy, Inc., 38 S.E.C. 658, 668-671, 1958
SEC LEXIS 807, *25-29 (Nov. 28, 1958) (acquisition of a single power
plant where applicants had contractual use of necessary transmission
facilities for the entire life of the acquired plant); New England
Electric System, 38 S.E.C. 193, 198, 1958 SEC LEXIS 620, *12 (Feb. 20,
1958) (finding that ``the necessary interconnections would be
constructed forthwith if the present [transmission contract]
arrangements with the non-affiliate companies were terminated'')
(emphasis added).
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Most recently, on January 18, 2002, the U.S. Court of Appeals
vacated and remanded the Commission's approval of a merger between
American Electric Power and Central & South West Corporation. Nat.
Rural Elec. Coop. Ass'n v. S.E.C., No. 00-1371 (D.C. Cir. Jan. 18,
2002).\8\ The AEP merger created the nation's largest registered
holding company, with utility properties extending from Virginia in the
east, to Michigan in the north, to Texas in the southwest. The service
territories of the operating utilities of AEP and CSW are separated by
several hundred miles at their closest point. The only proposed
``physical'' connection between the two system was a one-way
transmission contract for a token amount of electric capacity--less
than one percent of the combined systems' generating capacity. The
Commission's approval of the AEP-CSW merger culminated more than 20
years of SEC decisions approving virtually any proposal placed before
it by utility holding companies coming under its purview.
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\8\ This law firm represented the petitioners in this case.
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The Court vacated the SEC's approval of the AEP merger on two
grounds. First, the Court ruled that the SEC failed to explain how a
one-way transmission contract could meet the interconnection
requirement of the Public Utility Holding Company Act. The Commission
also said the agency had failed to explain how its interconnection
ruling was consistent with prior agency decisions, calling the SEC's
explanation of its prior decisions ``peculiar.'' Second, the Court
ruled that the SEC erred in finding that the merged company satisfied
the ``single area or region'' requirement of PUHCA Section 2(a)(29)(A).
The Court found that the SEC had failed to cite any evidence in support
of its ``single region'' finding, and that the agency's method of
analyzing the single region requirement was flawed. Given these errors,
the Court said ``the Commission's decision that New AEP meets the
region requirement cannot withstand even the most deferential review.''
Slip Op. at 8.
B. Comments on S. 1766
With this backdrop, I would like to comment on Title 2 of S.1766.
Title 2 seeks to set forth the key prerequisites for competitive
evolution and consumer protection. It is a solid beginning step. I
offer some comments below on provisions relating to mergers and market-
based rates.
1. Electric Utility Mergers (Section 202 of S. 1766)
a. Inclusion of important merger transactions: The bill correctly
attempts to clarify the universe of transactions which require
Commission approval. It appears, however, that several types of
transactions are missing.
First, the language does not seem to address the type of
acquisition where the acquiree is a retail seller but does not own
generation. Such an acquisition can endanger the nascent retail
competition efforts in some states. These acquisitions are likely to be
multistate in nature, and one or more states might lack jurisdiction
under state law. Moreover, some states that have reviewed retail
mergers have said they will not look at the merger's effect on retail
competition because they have not yet authorized competition, even
where the very parties to the merger have defined their objective as
``getting ready for retail competition.''
Second, although the language does create FERC jurisdiction where
the acquiree has generation, transmission and distribution facilities,
it is not clear that FERC is obligated to assess the effect of the
merger on retail competition. FERC's Merger Policy Statement
establishes the odd principle that it will review such effect if the
state commission requests. FERC's obligation to review the retail
effects in all cases should be clear in the statute.
Third, concerning the phrase in new 203(a)(1)(C), ``purchase,
acquire, or take any security of any other public utility'': consider
amending it to add, after ``security,'' the phrase ``any indicia of
ownership or control,'' since there may be forms of control like
partnership shares, or leases, that do not come within the definition
of ``security.''
Fourth, new section 203(a)(2) correctly clarifies FERC jurisdiction
over mergers at the holding company level. But for purposes of this
section, ``holding company'' should be defined to include structures,
such as partnerships, in which the device by which ownership or control
of companies or assets is achieved is not through stock but through
other means.
b. Standards applicable to the merger: The amendments to Federal
Power Act Section 203 should include standards applicable to the
merger. Under PUHCA, an acquisition is allowed only after a finding
that it produces operational efficiencies, and does not tend toward a
concentration of control or create capital structure or corporate
structure complexities. As discussed in Part I.B above, FERC's review
of mergers does none of this, except for a review of competitive
effects on generation and transmission, and that review has been uneven
due to uncertainty of market concentration measures. Moreover, FERC's
competition review does address the merger's effect on the incumbents'
ability to protect their retail monopolies against future retail
competition, even as merging companies often give as a reason for
merging the need to ``prepare for retail competition.'' FERC's
approach, in short, fails to screen out mergers that are not the
product of, and contributors to, real competition.
As explained above, moreover, FERC's review does not distinguish
adequately efficient from inefficient mergers. The result has been an
accelerated consolidation process in our industries that has set back
substantially the cause of wholesale competition that FERC is trying to
achieve elsewhere.
2. Market-Based Rates (Section 203 of S. 1766)
a. Prerequisites for market-based rates: Before authorizing market-
based rates, the bill requires the Commission to ``consider'' various
features of the market. These features are the correct features to
consider. But the bill does not establish prerequisites to market-based
rates. It does not equate ``just and reasonable rates'' with ``rates
which are the product of a fully competitive market.'' Under present
law, some have argued that supra-competitive rates charged in a
noncompetitive market are just and reasonable because they will attract
new suppliers and thus make the market competitive. Under this
formulation, consumers are not an interest to protect from the absence
of competition, but a source of funds used to create competition. As
discussed in Part I.B above, moreover, the Commission's past
methodologies on determining market competitiveness are deeply flawed,
by its own admission; and the Commission only now is beginning a new
inquiry into the correct methodology. There is not a consensus about
what are the minimum features of a competitive market, or about what
prices should look like in such a market. Given this uncertainty, the
legislation should be clear that vigorous competition is a prerequisite
to market rates.
b. Demand response mechanisms: The bill deserves special praise for
making clear that the adequacy of demand response is central to the
effectiveness of competition. In the past 20 years, excess attention
has been paid to creating incentives to suppliers, and insufficient
attention to the demand side.
c. Refunds: The bill should codify FERC's recent policy of
establishing, at the time it grants an applicant authorization for
market rates, that the right to charge those rates lasts only as long
as the rates are just and reasonable. With this approach, refunds can
be made back to the date on which the rates became unjust and
unreasonable, rather than the date on which someone filed a complaint
alleging that the rates were unjust and unreasonable. There can be a
significant time lapse between the time that (a) the market power is
exercised to make the rates unjust and unreasonable, and (b) that
exercise is noticed by someone and brought to the Commission's
attention.
d. Litigation costs: It costs money to bring a complaint to the
Commission. The complainant has the burden of proof, and it requires
lawyers and market experts to create that proof and carry it through
the litigation process. If successful complainants could recover their
litigation costs it would reduce the large disincentive to bringing
information to the Commission. Just and reasonable rates are the
seller's obligation and the Commission's duty. The customer should not
bear the cost of making the statute work. This feature could be
eliminated later, when competitive markets are the norm.
IV. ARGUMENTS FOR STANDALONE REPEAL LACK A FACTUAL BASIS
To construct a logical argument for repeal, one must assert that
the conditions requiring these protections no longer exist;
specifically, that (a) consumers are protected, either by effective
competition or careful regulation; and that (b) investors are
protected, by their knowledge and their sophistication. As explained
throughout this testimony, these assertions are inaccurate.
A. There is virtually no retail competition; and wholesale
competition is ineffective in many places and endangered in all places,
due to:
--the absence of regional transmission pricing and planning;
--the absence of a coherent merger policy that distinguishes
efficient from inefficient mergers and that stops mergers which
would damage wholesale or retail competition; and
--the absence of any feasible way to identify a real date
when reliable wholesale competition will exist.
B. Wholesale rate regulation is uncertain, due to the absence of a
consensus methodology and procedure on market pricing
C. Retail rate regulation is burdened by under-staffing and the
inherent difficulties of regulating, state-by-state, multistate
companies. Some argue that ``States can use ratemaking disallowances
and other devices to protect the consumer.'' Not when the company
already is weakened by its errors. Not a year goes by when some
investor group does not argue that a rate increase is necessary ``to
save the company.'' For example, when Pinnacle West had to borrow
hundreds of millions of dollars to pay off depositors of its failed
savings and loan affiliate, it had no choice but to pledge as
collateral its only asset: the stock of Arizona Public Service. Had the
State regulators tried to prevent this pledging, the outcome might have
been worse. On the other hand, had the SEC acted on a timely basis to
limit Pinnacle West's investments, the problems would not have
occurred.
D. Securities regulation largely focuses on disclosure, not on
prevention of abuse. On this subject, the following two statements
appeared in the same testimony supporting repeal of PUHCA:
``The SEC retains full authority over securities functions.''
`` `Our securities laws are, in the main, nearly seventy
years old, and reflect a time, and a state of technology, light
years away from what we now confront daily.' '' (quoting SEC
Chairman-designate Harvey L. Pitt, Testimony before the Senate
Banking Committee)
Testimony of David L. Sokol before the House Subcommittee on Energy and
Air Quality, Committee on Energy and Commerce (July 27, 2001). Both
views cannot be correct.
We need to assure the workability of our federal securities laws
before we can rely on them as a basis for repealing PUHCA's reviews. In
any event, as discussed in Part I, federal securities laws focus on
disclosure only. PUHCA's protections are different: they focus on the
quality of financial activities, and their appropriateness to an
industry characterized by captive customers and unsophisticated, small
investors seeking stable investments.
At the state level, state commissions generally review security
issuances of utilities within their jurisdictions, but not issuances by
holding companies or by non-utility companies associated with such
utilities. The need for such review is underscored by the failures of
exempt holding company diversification in the 1980s. Utilities are
affected by such failures, both in their credit standing and in their
access to capital.
Other factors argue for continued federal review. Some states lack
authority to review financings by non-utility affiliates, and not all
utilities have worked with State commissions and State legislatures to
furnish this authority. Moreover, where utilities have mismanaged costs
or taken risks with negative results, regulation tends to hesitate. The
ultimate penalty in a competitive market, bankruptcy or takeover by a
stronger company, causes regulatory uncertainty that regulators often
prefer to avoid. There is a concern, for example, that the bankruptcy
court will require payments to certain creditors, and then preempt
state ratemaking to ensure that ratepayers are the source of these
payments. The risk of this type of event can discourage state
commissions from requiring companies to bear the costs of their own
risks. Given this uncertainty of ``back-end'' accountability, ``front-
end'' accountability in the form of advance review of financial risks
is critical.
These factors support establishing federal minimum standards for
the quality of financing, applied and monitored at the federal level.
Assuming there is a federal role in financial reviews, that role
should be consolidated with the financial reviews conducted by FERC
under the Federal Power Act.
E. Reliance on antitrust law is misplaced. Antitrust is aimed at
markets that are competitive, protecting them from anti-competitive
behavior. Antitrust does not address well markets that are
monopolistic, where actions entrench the incumbents further. The
purpose of advance regulatory review is to act as a ``first line of
defense,'' preventing market power problems before they infect a
market.
Also: Who would address the problem through the federal antitrust
laws? Antitrust lawsuits are expensive. An individual consumer lacks
the resource, and attorneys general must reserve their resources for
blockbuster cases like Microsoft and tobacco. They often can be brought
only ``after the fact.''
V. ENRON: PROPER APPLICATION OF PUHCA WOULD HAVE IDENTIFIED AND
PREVENTED ENRON'S ILL-FATED ACTIVITIES
Enron's acquisition of Portland General Electric, a utility, made
Enron a ``holding company'' under PUHCA. Enron Corp., a global holding
company, then obtained an ``intrastate'' exemption from the Act under
Section 3(a)(1). Without that exemption, Enron's financial dealings and
diversification efforts would have come under the full purview of the
Act. More than likely, the Act, if conscientiously applied, would have
limited or even prohibited the arrangements that apparently led to its
bankruptcy. I explain here the process by which it obtained the
exemption, and highlight the PUHCA provisions which the exemption
allowed Enron to escape.\9\
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\9\ This discussion focuses on Enron's exemption from registration,
obtained under Section 3 and Rule 2 of the Act, not on its receipt of
``no-action letters'' stating that its brokering and marketing
activities do not make it a ``gas utility company'' or an ``electric
utility company'' under the Act because those businesses do not involve
electric or gas ``facilities'' as defined by the Act. Enron Power
Marketing, Inc., SEC No-Action Letter (Jan 5; 1994).
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A. The Exemption Process
Section 3 of the Act authorizes the SEC to exempt a holding company
from provisions of the Act if the holding company satisfies one of the
five exemptions described in Section 3(a)(1)-(5). The SEC has used this
authority to exempt qualifying companies from all provisions of the Act
except the pre-acquisition review standards of Sections 9 and 10. The
key condition on a continued exemption is the ``unless and except''
clause of Section 3(a), which says an exemption is available
. . . unless and except insofar as [the SEC] finds the
exemption detrimental to the public interest or the interest of
investors or consumers . . .
Section 3(c) also allows the Commission to revoke an exemption if
it ``finds that the circumstances which gave rise to the issuance of
such order no longer exists.''
The most common of the five examples is the ``intrastate''
exemption of Section 3(a)(1), which directs the SEC to issue an
exemption if--
such holding company, and every subsidiary company thereof
which is a public-utility company from which such holding
company derives, directly or indirectly, any material part of
its income are predominantly intrastate in character and carry
on their business substantially in a single State inwhich such
holding company and every such subsidiary company thereof are
organized. . . .
Although Enron is a global holding company with worldwide
businesses, hardly ``intrastate in character'' and clearly doing
business ``substantially'' in more than a single state, it obtained
exempt holding company status under the intrastate exemption of Section
3(a)(1). The process for obtaining an exemption is as follows: An
intrastate holding company make seek a Section 3(a)(1) exemption in two
ways. It may obtain an official Commission order upon application under
section 3; or it may self-claim an exemption by filing under the SEC's
Rule 2, 17 C.F.R. sec. 250.2. Rule 2(a)(1) allows a company to obtain
the exemption afforded by section 3(a)(1) by filing annual claim of
exemption on form U-3A-2. Form U-3A-2 is a 2-page form seeking basic
information about the holding company and its operations. No Federal
Register notice is given to the public and no opportunity to comment
afforded. The claim must be renewed by annual filings on or before
March 1 of each year.
A claim to an exemption under Rule 2 is subject to Rule 6, 17
C.F.R. sec. 250.6. Under Rule 6, the exemption may be terminated by a
registered letter from the Commission stating that a question exists
about the holding company's entitlement to the exemption. A company
receiving a termination letter has 30 days to either register under the
Act or file a formal application for an exemption which, if filed in
good faith, exempts the company from the Act until the Commission
issues a final order.
On rare occasion, and in the very distant past (decades ago), the
Commission has questioned a Rule 2 claim of exemption. However, we
found no modern decisions indicating any such Commission activity.
Moreover, the Commission has no procedure by which a customer can
file a complaint for revocation of an exemption should it become
``detrimental to the public interest, or the interest of investors or
consumers,'' as forbidden by Section 3. In the two situations where
such a complaint has been filed, both involving extraordinarily serious
situations, the Commission has taken no action.
Specifically, in May 1990, the Arizona Corporation Commission filed
a complaint asking the Commission to revoke the intrastate exemption of
Pinnacle West, the holding company Arizona Public Service Company.
Pinnacle West had invested in Merabank, a savings and loan institution.
The failure of that institution in the late 1980s forced Pinnacle West
to borrow several hundred million dollars to bail out the depositors.
As collateral for that loan, Pinnacle West pledged its only asset: 100%
of the stock of Arizona Public Service.\10\ The Commission took no
action on the complaint. Also, last July the California Attorney
General filed a complaint seeking revocation of the intrastate
exemption for Pacific Gas & Electric as a result of its financial
troubles. The Commission again has not acted.
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\10\ The witness was counsel to the Arizona Commission in that
matter.
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B. Should Enron Have Received ``Exempt'' Status Under the Act?
There are two avenues by which the SEC could have found that Enron
should not have been an exempt holding company.
First, the SEC could have refused the exemption to begin with.
Enron clearly did not meet the requirements of Section 3(a)(1). Enron
Corp., the holding company, although organized in the state of Oregon
(the state from which it derived a material part of its income from its
Oregon public utility subsidiary, Portland General Electric), has
holdings and business activities throughout the United States and
abroad. The business of Enron Corp. is not ``predominantly intrastate
in character,'' and Enron Corp. does not ``carry on [its] business
substantially in a single State.'' Enron Corp. is global in character
and does business substantially in many states.
Second, the SEC could have found Enron's exemption would be, or had
become, detrimental to the public interest or the interests of
investors or consumers. Had the SEC investigated Enron's business
activities during the exemption period, either before granting the
exemption or as part of a periodic review, it should have been able to
identify business dealings causing the detriment. But Enron's exempt
status, plus the absence of any SEC review of exempt holding companies
for detriment, meant that the statutory protections were not operating.
C. Customer and Investor Protections From Which Enron Was Exempt
Had Enron been treated as a registered holding company, those
activities leading to its present state would have been curbed or
prohibited, assuming the Act were applied conscientiously.
Specifically:
Limitations on Utility Diversification: The off-shore financial
transactions reported to be responsible for Enron's collapse should not
have occurred if Enron had been treated as a registered holding
company, because:
Section 11(b)(1) limits the operations of registered holding
companies and their subsidiaries to ``businesses [that] are
reasonably incidental, or economically necessary or appropriate
to the operations'' of their public utility operations. The SEC
has interpreted the section 11(b)(1) language to permit non-
utility businesses that are only ``functionally related'' to
the utility business.
Section 11(b)(2) requires the elimination of unnecessary
corporate complexities and inequitable voting power among
security holders. Specifically, the section requires the
Commission to ``ensure that the corporate structure or
continued existence of any company in the holding-company
system does not unduly or unnecessarily complicate the
structure, or unfairly or inequitably distribute voting power
among security holders, of such holding-company system.''
Regulatory Review of Accounting and Financing: Regardless of
whether Enron's offshore transactions would been barred by the
diversification provisions applicable to registered holding companies,
Enron's excesses would have faced the prohibitions and limits of
Sections 6 and 7:
Sections 6 and 7 govern the issuances of securities of RHCs
and their subsidiaries. Section 6 requires SEC approval of most
issuances and sales of securities by registered holding
companies and their subsidiaries, and section 7 establishes
specific guidelines for the SEC to follow in approving such
issuances and sales.
Section 7 prescribes standards for the type and amount of
securities for the registered holding company and its
subsidiaries. Section 7(d), for example, requires that a
security be reasonably adapted to the earning power of the
issuing company and to the capital structure of the company and
the holding-company system. Registered holding companies and
their subsidiaries must also obtain SEC approval before
acquiring any securities, utility assets, or any other interest
in any business.
In sum, sections 6 and 7 demand much more than the accounting
standards and private review standards that were applied to Enron's
investments.
Regulatory Review of Inter-affiliate Relations: PUHCA Sections 12
and 13 would have required the SEC to police transactions among the
various Enron affiliates.
Section 13 governs service, sales and construction contracts
between system service companies and associate companies in the
same holding company system.
Section 12 polices inter-affiliate transactions in loans and
other securities, requiring arms length relations between
affiliated companies.
Section 12 also precludes registered holding companies from
borrowing or receiving any extension of credit or indemnity
from a public utility subsidiary. It also gives the SEC
rulemaking authority over other types of affiliate transactions
such as: intra-system loans; declaration and payment of
dividends; acquisition, retirement or redemption of a company's
own securities; disposal of assets and securities; solicitation
of proxies in connection with holding company and subsidiary
company securities; books, records, disclosures of interest,
duration of contracts; and similar matters concerning affiliate
transactions. From press reports, it would appear that many of
Enron's financial dealings would have fallen under these
standards applicable to registered holding companies.
VI. CONCLUSION: THE CONSEQUENCES OF A WORLD WITHOUT A FEDERAL CORPORATE
STRUCTURE STATUTE
The repeal of the Public Utility Holding Company Act, with no
change in other statutes, would allow:
A. Acquisitions by utilities of other utilities, undisciplined by
market forces and without adequate review of
--the costs and benefits to present and future
consumers,
--the effects on retail prices and retail
competition, and
--the effects on wholesale prices and wholesale
competition.
The risk of consolidation would be less if there were (1)
comprehensive, nondiscriminatory and efficient retail competition; or
(2) predictable, low-cost and efficient franchise competition. Both (1)
and (2) are largely nonexistent, leaving the retail sector subject to
utility market power. Unlimited and unreviewed retail acquisitions
could increase this market power, thereby contradicting the claims that
``competition is here.''
B. Unlimited mixing of utility and non-utility businesses, where
the risks of business failure are borne in part or in whole by
consumers who are prohibited by law from shopping, subject only to
post-failure regulatory devices of proven insufficiency; while
ratepayer obtain none of the benefits.
C. Unlimited inter-affiliate transactions between the utility
serving captive customers, and affiliates needing utility resources
paid for by those customers.
D. Unlimited use of corporate structures that transfer ratepayer-
funded assets to deregulated companies.
E. Unlimited use of corporate structures that cause Federal Power
Act preemption of state review of the prudence or economic value of
utility historic investments.\11\
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\11\ See Mississippi Power & Light v. Mississippi ex rel. Moore,
487 U.S. 354 (1988) (holding that where FERC issued an order allocating
a specific portion of the costly Grand Gulf nuclear plant to a utility,
the state could not regulate the utility as if it had bought a lesser
portion); Nantahala Power & Light v. Thornburg, 476 U.S. 953 (1986)
(holding that FERC order allocating a portion of a low-cost
hydroelectric plant to a utility preempted the state from treating the
utility as if it were entitled to a higher portion of the hydropower
than FERC had assigned)
---------------------------------------------------------------------------
F. Entry by utilities with government-granted market power into
potentially competitive industries, while continuing to use resources
financed by customers who lack competitive options.
The electric industry lacks effective competition in many markets.
Congress cannot nurture competition by giving free rein to companies
which for a century have avoided competition. And Congress cannot
protect consumers by confusing financial entry with competitive entry.
To repeal PUHCA without establishing a modern regulatory regime--one
that conditions acquisitions on real competition and attentive
regulation--is to allow dominant incumbents to exploit unearned
advantages. Calling the result ``competition'' is good fiction, but it
is not good policy.
Thank you for the opportunity to present this testimony. I look
forward to any questions from the Committee.
The Chairman. Well, thank you very much. Thank you all for
your testimony. I think it has been very useful.
Let me try to understand the differences in point of view
that have been expressed here. I think it is fair to say that
each of the first four witnesses essentially agreed with the
proposition that we should repeal the Public Utility Holding
Company Act and, at the same time, grant to FERC additional
authority to protect consumers in some of the ways that
currently are contemplated under the Public Utility Holding
Company Act but are not working very well. That is sort of the
impression that I am getting from the first four witnesses.
Now, Mr. Hempling's testimony is somewhat different, but he
does take the position that, as I understand it--and this is on
page 14 of your testimony--that Congress should modernize
certain PUHCA protections and transfer regulatory
responsibilities to FERC. So, there is no disagreement among
any of the witnesses about the wisdom of transferring these
responsibilities under PUHCA to FERC. Is that a fair statement?
Do you agree with that, Mr. Hempling?
Mr. Hempling. That is correct, sir.
The Chairman. So, the real question then is, if these
responsibilities to protect consumers and to oversee and insure
against abuses in the utility business is transferred to FERC,
what should the protections still be, what should the authority
and the direction to FERC be to carry that out?
And that is where we have disagreement, as I understand it.
And I need to try to understand better precisely what those
disagreements are about the responsibilities that we are going
to put on FERC. Mr. Sokol, did you have a comment?
Mr. Sokol. I would only add to your comment, Senator, and
then try to answer the question. I think that not only
transferring a great deal of that opportunity to FERC but also
to the States. The States deserve the right to have greater
access to books and records, affiliate transactions, et cetera,
because with all due respect to a lot of the discussion here--
and by the way, Mr. Buffett is invested in a regulated utility
today but limited to PUHCA to 9.9 percent of the voting rights.
The States are aware of consumer protections that exist
today. There are effectively well in excess of 5,000 State
professional regulators in the United States. There are 22
members of the SEC PUHCA staff. This notion that that 22-member
staff can do a better job than the State regulatory bodies I
think is wholly unreasonable. By moving to FERC and giving the
States those additional rights, the States can protect the
consumers. They will have access to both affiliate and books
and records information, which they must have, and then FERC
can have a much greater oversight on the wholesale activities
that also play very, very significantly in the States' proper
regulation.
I think those are where they need to be. The notion of
arbitrarily, as Mr. Hempling would argue that it is a bad thing
for a AAA-rated company like Berkshire Hathaway to own Portland
General, if it is properly regulated and there is properly
access to books and records--that somehow that is a bad thing I
would just submit is comical.
Northwest Natural Gas is a fine small company, but by them
being, if you will, forced to buy Portland General because
Enron could not find anyone else, now Portland General is going
to be forced to take on a very substantial debt load. We would
buy them with cash. The regulator would have a much simpler
time dealing with that situation. I am not trying to criticize
Northwest Natural Gas.
The Chairman. Let me ask Mr. Hempling to comment, but let
me just first clarify the question. Enron's ownership of the
utility in Oregon has resulted in higher rates, as I understand
it.
Mr. Sokol. I do not think that is correct. I think the
higher rates in Oregon--and the commissioner is here--that had
to be raised the last couple of years were caused by the
California problem and the west coast escalation of wholesale
rates, not by Enron.
The Chairman. So, the higher rates are not a result of
Enron's involvement, but looking forward, the complaint now, as
I understand it, from some is that once this utility in Oregon
is acquired by Northwest Natural Gas, the consumers, the
customers of that utility, are going to be paying higher rates
because they will, as you say, have to be paying to cover this
debt load.
Mr. Sokol. I think there is the fear of that. I do not
believe the regulatory body will allow that to happen. There
are consumers who are postulating that that is the case. The
risk that comes, though, is that by a company becoming highly
leveraged to own a regulated utility like Portland General--if
they get into financial trouble, will there be an attempt to
try and convince the regulator that they should raise the
rates? I do not believe the transfer of Portland General to
Northwest Natural Gas should cause any change in rates.
Regulators are fully capable of imputing the proper cost of
capital and not charging consumers----
The Chairman. Let me ask Mr. Hempling. Is it your view that
Berkshire Hathaway or any other company should be prohibited
from coming in and purchasing a utility in Oregon as they
currently are under PUHCA, even though, as you point out, that
does not add to the competition? It is essentially purchasing
an existing monopoly. But the argument being made by Mr. Sokol
is they will run the existing monopoly very well and it will be
a benefit to the consumers for them to be the owner of it,
rather than having someone else the owner. What is your
response to that?
Mr. Hempling. My view, as stated expressly in the
testimony, apparently disregarded by Mr. Sokol, is as follows.
I would be delighted to have Mr. Buffett or anybody else in
this industry acquiring any number of retail monopolies. I
would be delighted for that to happen.
He needs to make a showing. He needs to make a showing that
this acquisition is going to improve service for the customers
of the acquiree. He needs to make a showing that his
acquisition will not harm the customers of the utilities he
presently owns. He needs to make a showing that his global
investments in other businesses are sufficiently fenced off
from the acquired company that there will be no risk.
He needs to do this in a context where there is a
competition for the right to acquire this new utility because,
sir, presently in the utility industry mergers are not subject
to a competitive process. Mergers are back room deals brought
to the commissions for approval. There is not, like there is in
the competitive market, fights among companies for the right to
acquire someone with the person who offers the most to the
customer getting the arrangement. That is not how mergers work.
So, to say that because of the conditions I wish to place
on the acquisition, conditions which mimic faithfully the
competitive market, that I somehow think it would be bad for
Mr. Buffett to enter this industry is intentionally to miss the
point. Mr. Buffett happens to be exactly what we need in this
industry if we can show that his entry is good for all
involved.
The Chairman. You are saying there are certain conditions
that ought to be required to be met by FERC, once they are
given this new authority, if they are. If Congress shifts this
authority over to FERC, we should insist that when they approve
acquisitions, such as the one we are discussing here, they
require certain conditions to be met.
Mr. Hempling. That is correct, sir.
The Chairman. My time is up. Senator Smith, let me call on
you, since we are going back and forth here, and then I will
call on Senator Wyden.
Senator Smith. Thank you, Mr. Chairman. I thank all of our
witnesses for being here, Roy, particularly you from Oregon. It
is good to see you. I am very curious about your perspective on
how this Enron debacle is affecting us in Oregon.
My own evaluation I think can best be summed up by an
unnamed Enron executive, as quoted in the New York Times on
November 10, 2001. He said Enron's achievement in creating a
regulatory black whole fit nicely with what he called the
company's core management philosophy, which was to be the first
mover into a market and make money in the initial chaos and
lack of transparency. Do you see that as an accurate
description of what Enron was doing?
Mr. Hemmingway. Senator Smith, I think with respect to
Enron's wholesale trading activities, that in many cases that
was the case.
Senator Smith. You think they were doing that in Oregon?
Mr. Hemmingway. No. With respect to their ownership of
Portland General Electric, there was an entirely separate
enterprise there, and Enron acted as an absentee owner and had
relatively little activity on a day-to-day basis with respect
to that company.
Senator Smith. Do you have reason to believe, though, that
they bought PGE to pick off the transmission rights into
California?
Mr. Hemmingway. Senator, there is no evidence that we have
seen that they have abused those transmission rights into
California.
Senator Smith. And you would know that.
Mr. Hemmingway. Not everything is transparent with respect
to that. That is something that I think is subject to
continuing investigation. Certainly transmission rights have an
influence on their ability to exercise market power, and you
had some evidence recently in front of this committee about
their ability to exercise market power in the Western market.
But I doubt that it is possible to use the transmission rights
to exercise considerable market power alone.
Senator Smith. I am glad to hear that.
You remember when Enron bought PGE in 1997. A condition of
the merger was that Enron agreed that there would be $141
million in merger-related benefits to customers. Have those
benefits been realized in Oregon?
Mr. Hemmingway. Senator, by and large they have. There are
some continuing obligations of that merger which are still
owing because the time has not expired. Our last rate case that
we concluded in August we think dealt with those final
benefits, and they will be paid to customers.
Senator Smith. So, you are satisfied we will get the full
benefit of that.
Mr. Hemmingway. Yes.
Senator Smith. Are you concerned about the report in the
Oregonian last Sunday that PGE collected more than $357 million
from ratepayers, most of which are Oregonians, since it was
acquired from Enron, in order to cover its Federal income
taxes? And apparently it did not pay any income taxes in those
years. Were you aware of that?
Mr. Hemmingway. We were not aware of what Enron's tax
situation was, Senator, until it was reported in the press.
Senator Smith. You do not have access to those records.
Mr. Hemmingway. We do not get their tax return.
But what we do as regulators--and I think this is true
across the country with all utility subsidiaries--is we look at
the companies that we regulate as if they were stand-alone
businesses. And we erected a firewall in 1997 between Enron and
Portland General Electric to ensure that Enron could not raid
PGE's assets and vice versa, that Portland General customers
would not be subject to any problems that Enron might run into.
Part of that firewall is us looking at PGE as if it were a
stand-alone company when we regulate it. So, we look at the
income taxes that Portland General would have paid if they were
a stand-alone company, and that is what is included in rates.
Now, if we were to do the opposite and tear down that
firewall, the situation might occur that Portland General might
be in a situation where one year they do not owe any income
taxes, but Enron or its parent might owe income taxes. Then
what do we do in that circumstance? Are we to charge ratepayers
for taxes that they would not otherwise owe in a stand-alone
company?
So, we have chosen to regulate it as if it were a stand-
alone company. It is certainly something we will be looking at
in the future as we deal with more complex ownership structures
of utilities. But I think the decision in the past was
completely defensible.
Senator Smith. Very good. I want to say publicly that the
Oregon Public Utilities Commission is very important, and we
need you to succeed.
My next question is do you have the resources to succeed at
the mission that we need you to do?
Mr. Hemmingway. Senator Smith, thank you. I believe we do.
We have been an independent regulatory agency. We are funded by
utility fees, so we are not subject to the problems in the
budget which are currently going on in the State of Oregon. We
have generally good cooperation with the entities that we
regulate. We do have concern, as I indicated in my testimony,
that industry consolidation will make our job more complex, but
with access to books and records and with cooperation of the
entities that we regulate, we believe we can continue to
regulate effectively.
Senator Smith. Very good.
One final question, Mr. Chairman. Did PGE buy high-cost
power from Enron last year?
Mr. Hemmingway. Mr. Chairman, I do not know the details,
but I imagine they did. The question is, was that high-cost
power priced above market, and I do not believe it was. PGE
bought power from literally dozens and dozens of different
sources, and that power was priced at a very high price due to
the market conditions largely due to the California problem.
And those costs have been passed on to ratepayers such that PGE
industrial customers are now paying 50 percent more for power
than they were a year ago. That is not a fortunate situation.
But if there was market manipulation, it occurred throughout
the wholesale market and it was not something that PGE had any
control over. So, we were forced to pass those costs along.
Senator Smith. Can you just state, is there any instance in
which this Enron debacle has unfolded in which Oregonians have
been particularly victimized? From your regulatory standpoint,
where have Oregonians suffered from this?
Mr. Hemmingway. Well, certainly the employees, Senator, of
Portland General Electric have suffered terribly in their loss
of their 401(k) pension funds.
Senator Smith. But as to ratepayers.
Mr. Hemmingway. As to ratepayers, I do not believe so.
Portland General Electric still has access to the capital
markets. There is a question as to whether they are paying more
as a result of Enron or whether they are paying more as a
result of the problems in the industry as a whole. But overall,
this utility is able to function just as well as it did before.
Senator Smith. Thank you very much.
The Chairman. Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman. Thank you for
holding this hearing. I want to explore with our witnesses the
process and the decision that seems to have allowed Enron to
self-certify as qualified for a PUHCA exemption.
I want to begin, Mr. Hempling, if I could, with you because
in reviewing your written testimony last night, at page 29 of
the testimony you make a number of important points.
First, you point out that Enron was a global company and
therefore it should not have been eligible for an exemption
from PUHCA for holding companies that are predominantly
intrastate in character and carry on their business
substantially in a single State.
Second, you make the point that a proper application of
PUHCA would have prevented the activities that led to Enron's
collapse.
On your first point, could you briefly tell us why Enron
should not have qualified for an exemption from PUHCA?
Mr. Hempling. Yes, sir, Senator Wyden. The exemption under
which Enron operated after its acquisition of Portland General
Electric is the exemption set forth in section 3(a)(1) of the
act. It is commonly known as the intrastate exemption.
The language of the statute literally requires that the
holding company and each of the utility subsidiaries from which
it gains a material amount of income must be predominantly
intrastate in character and must do business substantially in a
single State. These requirements apply distinctly to the
holding company, as well as to the utility subsidiary.
So, the analysis is whether Enron Corp., the holding
company, which owns pipelines, gas companies throughout the
United States, which has holdings throughout the world, is
predominantly intrastate in character and whether Enron Corp.,
the holding company, does business substantially in a single
State. Common sense would tell you that it does not.
Senator Wyden. Now, you also say in your written testimony
that the SEC could have found that Enron should not have been
an exempt holding company. Is it your view that the SEC abused
its discretion in not challenging Enron's claim that it was
exempt from PUHCA?
Mr. Hempling. As a lawyer, I probably would not use the
term ``abuse of discretion'' because I do not think the SEC had
any discretion in this area. The statutory language is plain
that the ``predominantly intrastate in character'' requirement
and the ``doing business substantially in a single State''
requirement applies to the holding company as well as to the
utility. There is no discretion. So, what we have is not an
abuse of discretion. We have simply a disregard for the
statutory language.
Senator Wyden. The law does seem clear on its face to me,
and you have now said that the SEC disregarded the plain
language of the law. How in your view was it that Enron was
able to get this exemption from PUHCA despite the clear
language of the law? What was the process that caused this to
happen?
Mr. Hempling. The process under the SEC regulations
provides an applicant for exemption with two options. One is to
ask the commission for an order, and the other is to certify on
its own that it meets the exemption. It is my understanding
that the self-certification approach that is made available
under rule 2 of the SEC's regulations under the act was the
path selected.
Senator Wyden. So, there was no notice to the public here,
no hearing. Basically the public just learns about the self-
certification, as you call it, after the fact.
Mr. Hempling. I believe that is correct. Commonly, in
contrast, under the Federal Power Act, when a utility wants
something, it makes application. The application is noticed by
the FERC in the Federal Register. Those who make a habit of
reading the Federal Register daily find out about it, have an
opportunity to intervene, protest, ask for a hearing, and upon
being aggrieved by a commission decision, take the matter to
court. That process does not exist under rule 2 under the
Holding Company Act.
Senator Wyden. Did this self-certification occur in 1997
when Enron acquired PGE?
Mr. Hempling. I think the form that was filed by Enron to
gain the exemption was a 1997 filing, yes, sir.
Senator Wyden. Now, has anyone tried to challenge these
self-certification processes that Enron won? Or is it just sort
of stacked against public scrutiny of these exemptions?
Mr. Hempling. Well, the scrutiny is possible because you
can find out about it afterwards, Senator, but the process by
which the exemption is granted is not readily accessible. I
have a batting average in appealing SEC orders that is somewhat
to the south of Sammy Sosa's, and one of the reasons why it is
so low is because the appealability of an intrastate exemption
does not exist. It is viewed by the courts as not an agency
action and therefore one cannot--at the least the Ninth Circuit
said one cannot--challenge an exemption that is obtained this
way.
Senator Wyden. Now, on your second point, you say--I'll
quote you. ``Had Enron been treated as a registered holding
company, those activities leading to its present state would
have been curbed or prohibited, assuming the act were applied
conscientiously.'' Are you saying that SEC enforcement of PUHCA
could have avoided or at least minimized the collapse of Enron?
Mr. Hempling. I think that is correct, Senator. Now, I do
not want to pose as an expert on the Enron debacle. There are
several million other people who are doing that right now. But
I will say that as a registered holding company, Enron would
have been subject to three types of provisions under the act.
The first provision, section 11(b)(1) would require Enron
to have limited its activities to those that are incidental to
or reasonably necessary or appropriate to the operation of an
integrated public utility system. That means that any of the
diversified activities, the ones that do not involve the core
business of running an electric system, would have had to have
been discarded. To the extent the Enron problems flowed from
those types of businesses, the Enron problems would not have
arisen had the required divestiture taken place.
The second type of provision relates to inter-affiliate
transactions. Registered holding companies are subject to
sections 12 and 13. Section 12, in particular, deals with
financial transactions between affiliates. Issuances of
securities, guarantees of debt, injection of equity, and those
types of arrangements would have had to have been approved, as
consistent with the public interest, by the SEC if Enron were a
registered holding company. As an exempt holding company, there
is no SEC jurisdiction over them.
And the third area would be sections 6 and 7 of the act
which relate to the issuances of securities generally, which
are reviewed not merely for accuracy but for prudence and
reasonableness. A subsidiary or a holding company issuing debt,
which is a registered holding company, would have had to
satisfy the SEC's public interest criteria.
So, my position was that were registered status to have
applied, which it would have applied had there not been the
intrastate exemption, there would have been those three
junctures at which review of the Enron situation would take
place.
Senator Wyden. I thank you and thank you, Mr. Chairman,
because I want to follow up now with Mr. Hunt briefly with
respect to what Mr. Hempling has said because this raises in my
mind some serious questions about commission policy.
As you just heard, Commissioner Hunt, Mr. Hempling's
answers raised some very serious questions that in 1997 the
Securities and Exchange Commission allowed Enron to self-
certify it was eligible for an exemption when it was not, and
had the law been properly applied, Enron's collapse in his
judgment could have been avoided. You all were at the
commission at that point. The statute seems clear on its face
that both the utility and the holding company have to be
primarily in one State to qualify for the exemption.
Did the commission's review of Enron's certification that
it was exempt from PUHCA as a predominantly intrastate company
find that it was not a global concern?
Mr. Hunt. Well, sir, we do not think that Enron could have
engaged in its core business of energy marketing if it had been
registered as a registered holding company for some of the
reasons that Mr. Hempling cited: the geographic area
restrictions in the statute, the uniform, efficient operation
of a company. We just do not think that if Enron had been
registered as a registered holding company, they would ever
have gone into the business that got them into trouble. They
just, in our view, could not have done it as a registered
public utility holding company.
In 1994, as I mentioned in my testimony, the staff did
grant a no-action letter in which the staff agreed not to
recommend enforcement action if they operated as a power
marketing company because we and the staff, at that time,
thought that the power marketing business was not a business
that made them a public utility, generating and transmitting
energy. So, in 1994, the staff issued a no-action letter.
And then in 1998, I think, not in 1997, when they acquired
the Portland General Electric Company, they did claim the
exemption under rule 2, and we did think at that time that,
because of the incorporation of the holding company, the
operation of the utility in the same State of incorporation,
that it was entitled to the intrastate exemption insofar as it
was a utility holding company, as opposed to its other
operations. The core of its problems, the power marketing--
again in 1994, we took the position that that did not make the
company a registered utility holding company.
Senator Wyden. The only thing that troubles me about that
answer, Mr. Hunt, is energy marketing is a separate issue from
the company that owned PGE. And what Mr. Hempling said is this
does not come close. Does not come close. I asked him about
whether the commission possibly abused its discretion in
granting the exemption. He says it is not even a close call. He
said the law is very clear. He said this is a global concern.
It is not an intrastate concern. And you are talking about
apples when the law specifically mentions oranges.
I would like to have a second round on this, Mr. Chairman.
I know Senator Cantwell has questions she wants to raise.
Mr. Hunt. Mr. Chairman, could I respond to that?
Senator Wyden. Yes, I would like that. I would like to know
about what the process was for considering this.
The Chairman. Why don't you go ahead, Mr. Hunt, and
respond, and then we will call on Senator Cantwell for a round
of questions.
Mr. Hunt. Senator Wyden, in looking at the status of
utility holding companies as to whether they are entitled to
the intrastate exemption or any other exemption, we do not look
at what we consider non-utility activities, and we did not
think that the so-called global activities of Enron were
activities we should look at in terms of determining its right
to or non-right to the intrastate exemption. And since we did
not consider its power marketing global activities utility
activities, we did not look at those activities in coming to
the conclusion that it was entitled to the intrastate exemption
under rule 2. That is a longstanding position of the
Commission.
Senator Wyden. Well, Mr. Hunt, let me read the language Mr.
Hempling is referring to. It says holding companies and all the
subsidiaries have to be intrastate. I am looking right at the
statute.
Mr. Sokol. Senator, as a 3(a)(1) exempt company, can I try
to respond to that? We have exactly the same exemption and we
are a global company as well.
The language--and let me read it slowly--says, ``such
holding company, and every subsidiary company thereof which is
a public-utility company''--that is a defined term under the
act--``from which such holding company derives, directly or
indirectly, any material part of its income are predominantly
intrastate in character and carry on their business
substantially in that single State in which such holding
company and every subsidiary company thereof are organized.''
I am not defending Enron, but Enron Corporation is
incorporated in Oregon and its public utility, only public
utility it owns, which is Portland General, is only in the
State of Oregon. And by the way, we are the same. We have a
utility that is predominantly in the State of Iowa, and we have
global operations. I do not think there is any lack of
discretion or appropriateness in the 3(a)(1) exemption for
Enron.
Senator Wyden. Can we just hear from Mr. Hempling on that?
I just think the statute is very clear.
Mr. Hempling. I do not think there is any confusion here. I
think that Commissioner Hunt described the policy of the SEC,
as I have understood it, accurately. It is the policy of the
SEC that, when looking at the holding company, as distinct from
the public utility, when it looks at the holding company, it
only looks at the holding company in its capacity as an owner
of a public utility company, and if the holding company in its
capacity as an owner of a public utility company is intrastate,
then it will grant the exemption. As I have suggested, I see no
discretion upon which one can give that answer because it
simply says ``such holding company.''
Now, Justice Scalia once said when the legislative history
is ambiguous, there is no prohibition in looking at the words
of the statute.
[Laughter.]
Mr. Hempling. But even if one does look to the legislative
history, one finds that the abuses which led to the enactment
of the act had to do with the holding company and not merely
the holding company in its capacity as the owner of a public
utility company but the holding company as a form of doing
business which controlled vast types of businesses and assets
which had little or nothing to do with the public utility
business. That is why the distinct phrase holding company,
unlimited by the interpretation that the commission has been
giving it, is in the statute.
Senator Wyden. Thank you, Mr. Chairman.
The Chairman. Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman, for holding this
important hearing today on the Public Utility Holding Company
Act and its effect on the energy markets and consumers.
I have a question for Ms. Marlette about some of your
testimony as it relates to, obviously, the changes that you are
recommending and oversight, but particularly as it related to
your comments on FERC's authority to prescribe RTO's.
Let me first say I understand conceptually how RTO's
provide benefits to consumers in some regions of the country.
However, as you are probably aware, the Northwest situation is
unique in the amount of power generated by Bonneville, which
does not fall under the commission's jurisdiction. It already
has a centralized grid and in some sense it owns 75 percent of
the region's transmission system.
So, the question on the minds of many of our constituents
is what kinds of benefits can an RTO provide to us in that
Northwest parties are already engaged in the vigorous
discussion of RTO's. So, I want to caution FERC in thinking
that a one-size-fits-all RTO system would be a reasonable
approach to this and get your comments on specifically the
interrelation to this and PUHCA reform and to the Northwest.
Ms. Marlette. We are certainly well aware of the concerns
of the Northwest with respect to RTO's, and as you probably
already know, we are undertaking a cost-benefit analysis, which
we hope to get back soon, to look at the benefits to the
specific regions. Generally, the major benefits of an RTO--to
me, the biggest benefit is eliminating undue discrimination in
the access to and pricing of transmission, including
eliminating pancaking of transmission rates, and also providing
a forum for regional transmission planning so that States
within a region can come together and the RTO can be a focal
point for that planning.
But, as I said, we are looking at the specific cost
benefits. It is a pending issue at the commission. When we
issued Order 2000, we did a cost-benefit analysis, and that is
being updated.
Senator Cantwell. I think you can understand that given the
Northwest's unique nature and then what has transpired, how
crazy people would think that a west-wide RTO, given all the
problems that have thus occurred, would be for the Northwest to
participate in.
Ms. Marlette. The Commissioners are well aware of that and
the concerns about not imposing a one-size-fits-all and
particularly the concerns in the Western part of the country,
in light of California.
Senator Cantwell. I wanted to follow up too. This is
somewhat of a follow-on to last week's hearing about the
unregulated nature of energy markets and the link to get long-
term power pricing. You may or may not know, but I am assuming
you know since you are of counsel there, that I asked Chairman
Wood about a 206 investigation. In fact, I think he said we
will get an answer one way or another and we will commit to
doing that for you. So, have you, in fact, opened up a 206
investigation?
Ms. Marlette. I have the letters on my desk, as do others,
both yours and Senator Wyden's. To formally, officially open a
206 investigation, a majority of the Commission would need to
vote to do that under the Federal Power Act. So, we have not
issued any orders as yet.
The Commission is looking at trying to do some fact finding
as we speak, to gather some information.
One point I should try to make clear is that under 206, the
Commission's authority is to open investigations as to public
utility contracts, the entities that we regulate. We do not
directly regulate EnronOnLine. We have not asserted
jurisdiction over it itself as a public utility. So, any 206's
would be into the rates under the seller's long-term contracts.
That would be where a 206 would come in.
However, having said that, the Commission can certainly, in
fact-finding, gather information and we are going to do that
with respect to the EnronOnLine activities.
Senator Cantwell. Well, I just want to point out that we
have been consistent about the investigation of long-term
contracts, given that that was the price manipulation that the
Northwest felt was going on last spring. So, we have been
consistent in asking for an investigation and, when the price
cap or price mitigation plan was put into place, that long-term
contracts be looked at. So, I really believe that any
hesitation by FERC will be viewed very negatively in not being
cooperative in getting to what really has resulted in some
parts of our State in 50 percent rate increases that now
consumers will have to live up to for the next 3 or 4 years.
In fact, I am sure that probably what is happening is Enron
is buying cheap power at $30 a megawatt from some source in my
State, selling it to another utility for their long-term
contract, which was probably like $130 a megawatt. And that is
still going on today and consumers are going to have to
continue to pay that 50 percent rate increase, and I believe
that FERC needs to do its job to get that investigation
underway immediately.
Ms. Marlette. Yes, Senator. I do not want to be perceived
at all as the Commission hesitating, but what we are trying to
do right now at the staff level is fact gathering so that we
have enough to know how to go forward and whom to investigate
and how to frame an investigation. So, we are seriously
undertaking some fact-finding investigation.
Senator Cantwell. We look forward to your update as soon as
possible.
Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Mr. Hempling, let me ask a couple of things. You have
several suggestions for strengthening the language in S. 1766
as regards FERC's responsibilities. I think the way you put it,
you believe that FERC needs more substantial affirmative
authority. I think that was the phrase that I heard you use.
One of the suggestions there was that FERC should be
obligated to assess the effect of the merger on retail
competition, not just authorized to do so. Is that accurate?
Mr. Hempling. Yes, sir, that is correct. If I understand
the present FERC policy today, it is set forth in what is
called the FERC merger policy issued several years ago. It
includes a recognition that the retail customer is a concern of
FERC's even though retail ratemaking is not and the policy is
that upon the request of a State commission, I believe in the
context where a State commission has no jurisdiction over a
merger, the FERC will look into it.
I find that approach to be spotty because we have a
national infrastructure. Ultimately it is the retail customer
who pays the bill, who finances the industry, and we have
utilities whose very purposes for merging are to gain influence
and dominance in retail markets. So, because of the national
importance of the industry, I think relying on the episodic
request from a State commission, the public admission by a
State commission that it lacks jurisdiction, is a policy that
is not sufficiently comprehensive to protect the consumer
especially during a period where consolidation is occurring so
rapidly.
The Chairman. Mr. Hemmingway, do you have a problem with
that suggestion if we were to specify in Federal law that FERC
is obligated, in looking at these mergers, to look at the
effect the merger would have on retail competition?
Mr. Hemmingway. I have no problem with that. Senator, that
is exactly what we do in reviewing mergers under our statutes
in Oregon.
The Chairman. There is also a suggestion in your testimony,
Mr. Hempling, that the bill should codify FERC's recent policy
of establishing that the right to charge market rates lasts
only as long as the rates are just and reasonable. You think
that needs to be specified.
Mr. Hempling. Yes, sir. Ms. Marlette can speak to this more
authoritatively. It is my understanding that in the past,
before approximately December, if FERC had authorized a company
to charge what the market will bear and someone found out that
the market is no longer competitive so that rates are now just
and reasonable, that person or FERC could institute a complaint
proceeding and refunds would be available prospectively. But a
long period of time can go on between the time that the markets
turn noncompetitive and that complaint gets filed.
And I believe FERC in December recognized this notion and
intends to assign to all future authorizations of market-based
rates the statement that at any point in time that this becomes
unjust and unreasonable, even if we do not find out about it
afterwards, we will grant refunds back to that date. And I
think codifying that would remove the possibility that future
commissions, like past commissions other than this commission,
would miss the boat on protecting the consumer.
The Chairman. Ms. Marlette, do you have a problem with that
suggestion?
Ms. Marlette. Well, just a couple of clarifications. What
the Commission proposed to do--and we instituted a 206
investigation into all public utility tariffs, proposing to
place into all existing tariffs and future tariffs a condition
which says that if the seller is found to have engaged in anti-
competitive conduct, then it will be subject to refunds. We
could go back in time--those provisions have not taken effect
yet. We have asked for comment on it. Actually I think the
comments may be in by now. We do have a pending proceeding on
that issue, so I do not feel it appropriate to discuss whether
it ought to be legislated since I have not personally
considered all the views on the issue.
The Chairman. Mr. Hemmingway, in your testimony I believe
you have a statement that the books and records provisions that
are in S. 1766 should be strengthened, but you do not specify
in what way. Could you elaborate on that or tell us more
specifically how you would like to see those strengthened?
Mr. Hemmingway. Yes, Mr. Chairman. With respect to State
commissions, it requires that there be an open proceeding
before there can be a request for books and records. Many
utility commissions do ongoing audit efforts with utilities
without opening up a specific docket. We in Oregon tend to open
dockets on everything, but many commissions do not. It would be
fruitful, Mr. Chairman, if that provision could be broadened so
that State utility commissions did not need to open a
proceeding before requesting books and records.
The Chairman. One of the prohibitions that is in the Public
Utility Holding Company Act is this prohibition against
acquiring anything that is not part of an integrated public
utility system, as I understand it. As I understand everyone's
testimony, including yours, Mr. Hempling, everyone has agreed
that that does not make sense in the current economic
circumstance that we live in, that that prohibition that says
you can only acquire an asset or a business that is part of an
integrated public utility system--that that requirement is
obsolete at this point. Let me ask Mr. Hempling if you agree
with that.
Mr. Hempling. Making the concern a requirement is the
error. The concern itself is not. The distant collection of
monopoly assets based on inquisitiveness or market dominance is
still a concern. It is because of the possibilities brought by
an investor like Mr. Buffett, who seems to run a good business,
that I have suggested that that concern should not be
translated anymore into a prohibition. So, I think there is
complete agreement, as you pointed out, on that. The
fundamental difference has to do with whether the acquisition
is going to be reviewed sufficiently.
The Chairman. Let me go ahead and defer to Senator Wyden
for another round.
Senator Wyden. Thank you, Mr. Chairman. I just want to note
for the record that no one could ever question your commitment
to energy conservation because it is so cold on this side of
the dais.
[Laughter.]
Senator Wyden. You are doing more than your share.
I appreciate having another round.
The Chairman. We appreciate that rousing endorsement.
[Laughter.]
Senator Wyden. Commissioner Hunt, let me go back to
something you said in response to my earlier question. You said
in response to my earlier question that the SEC's decision to
issue the no-action letter in 1994 allowing Enron to engage in
energy trading without having to register under PUHCA, your
view was that Enron would not have been able to get into the
business of energy trading had it not been a registered holding
company.
Mr. Hunt. I think my statement, Senator, was I do not think
they would have been able to get into the business of energy
trading if they were a registered public utility holding
company because it is global in nature and their business would
have violated many of the restrictive aspects of the 1935 act.
Senator Wyden. Is it the principal job of the SEC to help
companies like Enron get into the energy trading business?
Mr. Hunt. No, sir. I think our principal job is to regulate
the securities markets of the United States and to provide for
the easy raising of capital for American industry and to
protect investors.
Senator Wyden. Well, my read is it is SEC's job to enforce
the letter and the spirit of the law rather than help folks get
into the energy trading business.
Mr. Hunt. Senator, we gave this kind of relief to 20
companies after we gave the relief to Enron. We also
incorporated it into our rule 58, defining energy marketing as
a permitted non-utility business in 1997 after notice to the
general public. And of course, the rulemaking was a public
proceeding. In our rule 58, we said that the brokering and
marketing of energy commodities, including but not limited to
electricity, natural or manufactured gas and other combustible
fuels, was a permitted non-utility activity of utility holding
companies.
Now, people would have had a right to object to that rule
when we proposed it, but we defined energy marketing as a non-
utility activity for purposes of the 1935 act in 1997.
Senator Wyden. Well, again, what you are saying sure seems
to be different than what we have heard from Mr. Hempling. Mr.
Hempling described something that the public got no notice
about.
Mr. Hempling. Sir, if I may clarify.
Senator Wyden. Why do you not?
Mr. Hempling. Yes, sir, because I think there is nothing
about which Commissioner Hunt is saying that is not 100 percent
accurate. I want to make sure the record is clear.
When I talked about the absence of advanced public notice,
I was referring to the process by which the intrastate
exemption under section 3(a)(1) is granted. Commissioner Hunt
is, of course, correct that with respect to the declaration
that marketing, brokering, and other activities are determined
to be permitted for registered holding companies, that was
certainly done pursuant to the traditional notice and comment
rulemaking that the SEC and all agencies engage in. There were
no procedural defects associated with the rule 58.
Senator Wyden. Nobody is saying that.
I just want to go back to the issue that I have been
concerned about, that my constituents are concerned about:
there was not any public process with respect to this self-
certification.
Now, Mr. Hunt, during the time you served on the SEC, were
there ever any questions about the self-certification process?
Mr. Hunt. Certainly none that came to my attention,
Senator. I do not think so.
Senator Wyden. Now, in 1997, around the same time--this
would be a question again for you, Mr. Hunt--that Enron was
self-certifying it was exempt from PUHCA, Enron also sought
another exemption from the SEC. This was under the Investment
Company Act. Now, in seeking that exemption, Enron certainly
did not hide the fact that it wanted to expand its overseas
operation. Enron specifically requested an exemption from the
investment company statute to engage in foreign infrastructure
projects, and the SEC granted that exemption.
Mr. Hunt. Yes, sir.
Senator Wyden. Given that the SEC was on notice that Enron
was going to engage in overseas operations, that it was going
to be a global company, did anyone at the SEC compare that
filing with Enron's self-certification that it was exempt from
PUHCA because it was saying the company was primarily in
business in one State?
My reason for asking this I think is obvious. How can you
be a global company in one respect under one act the SEC
enforces, the Investment Company Act, and then be classified as
operating primarily in one State under another act the SEC
enforces which is PUHCA?
Mr. Hunt. Easy, sir. The Investment Company Act is designed
to get at companies that essentially hold investment securities
in other companies. What Enron was doing was engaging in
infrastructure, bridge, railroad, dam, projects around the
world. In many countries, the legal regimes of those countries
prohibit a foreign corporation from holding a majority interest
in any kind of corporation whether it is constructing
infrastructure items or other things. Therefore, Enron found
itself holding minority interests in companies around the world
in infrastructure engagements. But for an exemption from the
Investment Company Act of 1940, Enron would have, therefore,
been deemed to be an investment company because it may have had
over 45 percent of its assets invested in this way and perhaps
would have had more than 45 percent of its income derived from
these infrastructure engagements.
It was the Division of Investment Management's view that
this was not the sort of activity that the Investment Company
Act was meant to regulate, that the Investment Company Act was
meant to regulate such investments as are engaged in by mutual
funds or other investment companies, and that, under these
circumstances, given the business in which Enron was engaged
and going to be engaged, its security holders did not need the
protection under the Investment Company Act of 1940.
Senator Wyden. Mr. Chairman, I know my time is expired. I
want to wrap up by asking that an article from the Wall Street
Journal be entered into the record. It is entitled ``Enron's
Rise and Fall Mirrors Collapse of Middle West Utilities 70
Years Ago.'' Just in wrapping up, I quote from the article. It
says, ``In rapid order in 1934 and 1935, Congress passed the
Securities and Exchange Act, the Public Utility Holding Company
Act, and the Federal Power Act. These laws sought to break up
the power trusts and guarantee investors the information they
need to make informed decisions. More than a half century
later, Enron would figure out ways around part of those same
laws.''
I think what we have heard today--and again, these are very
complicated issues and you have been very gracious in terms of
letting us look at these issues--raises some very troubling
questions. I am not reaching any judgments at this point, but
certainly what we have heard--and particularly when Mr.
Hempling says it is not a close call here, there was not any
abuse of discretion, that the SEC in his judgment did not
follow the law on this issue, I think we ought to be digging
further. I am anxious to work cooperatively with you in this
regard.
The Chairman. Thank you.
Senator Carper, I had another few questions. Would you like
to go ahead first with your questions?
Senator Carper. I would like to hear your questions.
The Chairman. Well, I am glad to ask them and you can then
ask yours.
Senator Carper. Thank you.
The Chairman. Let me ask a general question. One of the
things the Public Utility Holding Company Act was intended to
accomplish was to prevent this cross-subsidization that we
worry about so that you do not wind up with ratepayers having
to subsidize other businesses that they have had no involvement
in. Mr. Hemmingway, you testified that you try to regulate
there in Oregon each company, each utility, as a stand-alone
business so that you work hard to be sure that there is no
cross-subsidization.
PUHCA, as I understand it, has a prohibition against it in
the sense that it says if you get into a business that is an
affiliated business, you have got to do business with that
business on a cost basis. So, one example would be if you buy a
lumber company to make electric poles, you cannot enrich your
lumber company by charging an unduly high price for those
electric poles and making the utility customer pay that price.
You have got to sell them at cost. Now, that is my
understanding of one thing PUHCA is trying to do.
Does the language we have in this S. 1766 adequately ensure
that that cross-subsidization will not be there once this
responsibility is transferred, if it is, if this legislation
goes through and the responsibility is going to be with the
State commissions and is going to be with FERC--does the
language we have here ensure against that cross-subsidization
as effectively as PUHCA has?
Mr. Hemmingway.
Mr. Hemmingway. Mr. Chairman, cross-subsidization is an
issue for any utility regulator because utilities often have
enterprises which are not regulated. They may do everything
from--we have had airplane leasing to real estate development
to coal development. And whether they are registered or come
under any purview of the Holding Company Act whatsoever. So,
any regulator is accustomed to having to separate out these
enterprises and to ensure that there is not any cross-
subsidization from regulated enterprises to non-regulated
enterprises. And the key there is being able to have access to
the books and records of the company to be able to audit them
and to make sure that that is not happening.
Now, when PUHCA is repealed, as is contemplated in S. 1766,
there is a provision with respect to the way that registered
holding companies are regulated that requires the allocation of
costs from an affiliated company to be done at cost, and it may
happen that it may suit regulators to look at market prices in
a situation where market prices, for instance, are well below
cost. It may well happen, for instance, that a utility has
developed real estate and the real estate market has dropped
and the question then comes before the regulator, must you
allow the cost of that real estate in the rates or can you look
at market. With the repeal of PUHCA, we would not be facing
that situation of having the SEC do that allocation of cost,
but we could actually look at market alone.
To sum up, the key to us is being able to have access to
the books and records of whatever corporate structure results,
whether it is a holding company or not, and if we have access,
we think we can effectively regulate.
The Chairman. Good.
Mr. Hempling.
Mr. Hempling. Yes, sir. It certainly is correct to outlaw
the types of transactions that lead to cross-subsidies, and the
bill does that appropriately. But the history of regulation and
the present of regulation is that there is a distinction
between transaction and structure. If one has the type of
corporate structure and market structure where there is an
incentive and opportunity to cross-subsidize, then all one is
doing is making far more work for the regulator at the other
end and creating far more uncertainty.
When I looked at the form filed by the Enron Corp. asking
for its intrastate exemption, I looked for the list of
subsidiaries that it had around the world, and it said, see
appendix 1. And when I went to appendix 1, it said, not filed
pursuant to regulation 202 of the SEC's S-T. And I asked a
colleague of mine who is in corporate law, what does that mean,
and he said, it is so voluminous that they asked for an
exemption from having to do it electronically because they
would have had to put too many things through a scanner.
The point is that one can have staff, one can be committed
to the policing of cross-subsidies. But I make most of my money
working within State commissions, and I am not aware of any
State commissions where there is surplus staff to review for
the cross-subsidies based on the increasing complexity
transactionally that will arise once the Holding Company Act is
repealed.
The Chairman. But now, what is your solution? Is your
solution that we say, if a company does have extensive other
holdings, like Berkshire Hathaway does, that we should not let
them in the utility business? Is that your solution?
Mr. Hempling. No, sir, not at all. My solution is simply
what the act does now, with the exception of the prohibition.
What the act does now is create an advance review. So, let the
Federal regulators, as well as the State regulators, look at
the corporate structure that is being proposed before the
acquisition and ask the simple question, are we going to have
the authority, the resources, the technical ability to trace
the cross-subsidies, at what cost? Is our legislative body
going to continue to fund us at the level necessary to incur
those costs? And if so, have at it.
The Chairman. So, you are saying if FERC has the ability to
do a prior review before Berkshire Hathaway could come in and
buy a utility or anybody else could come in and buy a utility,
and if the State commission involved has the ability to do a
prior review and say, okay, you can do it, then that satisfies
your concern.
Mr. Hempling. Yes, sir, if the reviewing agencies are
required to conduct a review and that they are required to
conduct it pursuant to the traditional public interest
criteria.
Now, I want to be clear. I am not talking about the 12-
month delay. I understand what competitive entry is. I run a
law practice where I compete. I do not want to get 6 months of
delay before I decide whether to bid on a job. But these are
the types of structural reviews that can be done concisely in
advance upon the proper filings of things, and then someone who
passes----
The Chairman. So, someone could come in and make a bid to
purchase a utility, and it would be conditioned upon approval
by the appropriate commissions, and that would be the end.
Mr. Hempling. Yes, sir. Again, what we would be doing is
retaining what is good about the act and eliminating the
obstructions that are in the act.
The Chairman. Mr. Sokol.
Mr. Sokol. Senator, I would just make two comments. First
of all, that is exactly what happens today and your bill will
only enhance that. I would ask the chairman of the Oregon
Commission whether he would allow--the thing I would disagree
with, Mr. Hempling, is it is not enough to just review it up
front because corporations change. The State regulators have
got to have the right to review it every time they want to
review it and have the access to information.
The Chairman. Do you agree with his point that both the
State regulators and FERC should have ongoing access to books
and records?
Mr. Sokol. As they require it, yes.
Mr. Hunt. Senator, if I may. We would not dictate the
rules, but FERC should have rulemaking authority to prohibit
those kinds of affiliated transactions that they find to
inherently have a conflict of interest.
The Chairman. Senator Carper, I have asked my questions.
Senator Carper. Well, good. Thank you, sir, for allowing me
to ask a few myself.
I apologize for being late. I serve on three committees
that are meeting this morning and I am trying to go from one to
the other and cover them all. The Senate is in session, and I
have been presiding for a while and speaking on the Senate
floor. So, I am just glad to be here. I am glad that you all
are still here.
I will be real honest with you. I have not had a chance to
read your testimony. I understand the basic reason we are
having this hearing is to try to get your input as to whether
or not some of the events that are involved around the Enron
bankruptcy raise concerns among some people that the regulation
of energy companies might be insufficient if we repeal PUHCA.
What I really would most appreciate is just for each of you
to take a minute and answer that question for me, and if there
is anything else that you want me to take out of this hearing
that you think, by golly, you have missed most of this, pal,
but there are one or two things you ought to know and here they
are. Just take a minute apiece and answer the basic question
for me.
Mr. Hunt. Senator, my name is Isaac Hunt. I am with the
Securities and Exchange Commission. We, fortunately or
unfortunately, administer PUHCA now.
[Laughter.]
Mr. Hunt. It is our position and has been for 20 years that
PUHCA is outdated, that most of the evils that PUHCA was meant
to remedy have been remedied, that more authority should be
given to FERC, the principal utility regulator, and to the
States to have complete access to the books and records of
utility companies so that they can guard against these cross-
affiliate transactions that we were just talking about with the
chairman.
We think that the State regulation has improved. We think
that FERC is clearly the agency that the Congress intends to be
principal utility regulator at the Federal level, and we think
we should be out of this business.
Senator Carper. Thank you for that direct response.
Others, please.
Mr. Hemmingway. I am Roy Hemmingway, the chairman of the
Oregon Public Utility Commission.
Senator Carper. Welcome.
Mr. Hemmingway. Thank you.
The Public Utility Holding Company Act is basically the
constitution by which the electric and natural gas retail
utility industry is structured today. We have hundreds of
relatively small enterprises serving retail consumers around
the country.
If PUHCA is repealed, we expect that there will be
considerably greater acceleration of consolidation in this
industry, and you can have your own opinion whether that is a
good thing or a bad thing. I think in many respects it would be
a good thing.
The concern, though, that we have as State regulators is
that that consolidation makes regulation more difficult and
more complicated and shifts some of that jurisdiction to the
Federal Government. We think that we can accommodate that
change if we have ability to investigate books and records and
if FERC has additional authority to approve mergers. But we
think that the Congress and the Federal agencies will need to
maintain vigilance because it is somewhat unpredictable as to
what kind of industry structure will result from repeal of
PUHCA and there may be abuses in the future that we cannot
anticipate at this time.
Senator Carper. Thank you.
Ms. Marlette. I am here as a staff witness.
Senator Carper. Are you with FERC?
Ms. Marlette. I am the General Counsel of the FERC.
Our Commission witnesses have consistently for the last, I
think, 5 to 6 years testified that PUHCA does need to be
repealed or reformed. We think it is inconsistent with
competitive markets right now. It encourages geographic
concentrations of generation, which actually can increase
market power, and it can serve as a disincentive to investments
in RTO's, regional transmission organizations.
There are certain areas of PUHCA which have actually
impeded our Commission's ability to protect the ratepayers
served by registered holding companies from affiliate cross-
subsidization, the issue that Senator Bingaman was talking
about a few minutes ago. I think that Senator Bingaman's bill,
the repeal, that would add access to books and records by both
State and Federal regulators of all members of the holding
company system would significantly enhance our ability to
monitor against market power and cross-subsidization, and it
would cure the problem that is in the act right now in that
regard.
Senator Carper. Thanks very much.
Mr. Sokol. Senator, David Sokol, CEO of MidAmerican Energy.
Our largest shareholder is Berkshire Hathaway.
I think we need to separate the issues. S. 1766 is a very
good bill, particularly the portions about PUHCA reform. We
must protect the access to books and records, affiliate
transactions, et cetera, and we must give the State and FERC
more authority there. We also have to get rid of those parts of
PUHCA that stop companies like Berkshire Hathaway from
investing in this sector so that we have high quality investors
moving industry forward.
Enron is a red herring in this sense. Enron had two PUHCA
exemptions: the 3(a)(1) which was appropriate, and the market
trading which was appropriate as well. Enron did not go
bankrupt because it bought Portland General Electric. In fact,
as the commissioner has stated, Portland General's consumers
were not harmed by Enron's bankruptcy. PUHCA is actually
inhibiting their ability to sell it to a credit worthy company.
Enron was not harmed because it was in the marketing
business of energy. Enron went bankrupt because of arrogance,
accounting fraud, and mismanagement. Those are the issues of
Enron. PUHCA did not stop it. In some ways, PUHCA may have
helped Enron do what they were doing, but again it was an
illegal activity based operation and it went bankrupt, as it
should, as other companies have in the past.
We cannot not move forward with energy modernization over
the excitement of Enron. We need to put executives in jail when
they break the law, and we need to hold auditors accountable.
But PUHCA has to be reformed if, in fact, we want to move
forward with the energy sector because right now we are on the
50-yard line. The Congress deregulated wholesale electricity in
1992, but we still do not have rule clarification throughout
the sector, and that is a serious mistake and frankly a recipe
for serious problems in the future if we do not fix it.
Senator Carper. So, we are on the 50-yard line. Who has the
ball?
Mr. Sokol. You all do.
[Laughter.]
Senator Carper. Is it a first down?
Mr. Sokol. First down.
Senator Carper. Before we turn to Mr. Hempling for a
closing word, you said there are three reasons why Enron went
down. Just say those again. I thought that was nicely put.
Mr. Sokol. Arrogance, accounting fraud, and mismanagement.
Senator Carper. Mr. Hempling.
Mr. Hempling. Thank you, Senator. The Holding Company Act
uses structural limits to protect consumers in an industry
where competition is ineffective and regulators are outmatched.
Those are the preconditions for repealing the Holding Company
Act. If wholesale competition works, if retail regulation
works, then the limitations imposed on entry by the Holding
Company Act are appropriate, but the record is that wholesale
competition is a work in progress. Many tasks lie ahead from
understanding regional transmission policy to learning how to
measure the competitiveness of wholesale markets. We have about
the best FERC we have had in years. It is struggling
determinedly with these issues, but it would be the last to say
that it could predict when these matters will be resolved.
We should adjust the Holding Company Act so that new
companies who can bring real benefits, real savings, real
competition to the market enter, but we have to make sure those
entries are pro-competitive. We have to do that by assuring
that the Federal Energy Regulatory Commission has the
appropriate tools to do so. The position that says repeal the
Holding Company Act and we will see how things work does not
take into account the realities of wholesale competition today.
Senator Carper. Well, my thanks to each of you. That was
very helpful for me. I am sure, Mr. Chairman, this is
repetition for you, and I apologize for that. But this has been
a good, helpful exchange. And we thank each of you for your
contributions and your presence.
The Chairman. I think that is a very good summary of the
testimony we heard. Thank you all very much. I think this is
very useful testimony.
[Whereupon, at 11:50 p.m., the hearing was adjourned.]
APPENDIXES
----------
Appendix I
Responses to Additional Questions
----------
Federal Energy Regulatory Commission,
Washington, DC, February 15, 2002.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate,
Washington, DC.
Dear Chairman Bingaman: Thank you for your letter of February 8
enclosing questions from Senator Richard C. Shelby and Senator Maria
Cantwell for the record of your Committee's February 6 hearing.
I have enclosed my responses to Senator Shelby's and Senator
Cantwell's questions. If you need additional information, please do not
hesitate to let me know.
Sincerely,
Cynthia A. Marlette,
General Counsel.
[Enclosures]
Responses to Questions From Senator Shelby
Question 1. Mr. Hempling has stated that the SEC did not apply
PUHCA in an appropriate manner when considering Enron's request for a
no-action letter with respect to engaging in power marketing
activities. In his statement, Commissioner Hunt said that if Congress
chooses to not repeal PUHCA it should be given to the FERC. If this
were to happen, could you please describe for us how FERC would apply
PUHCA to energy marketing activities like those engaged in by Enron?
Answer. My understanding is that Enron sought a no-action letter
for its power marketing activities on the basis that these activities
did not entail ownership or operation of generation, transmission or
distribution ``facilities'' under the definition of an electric utility
company under PUHCA. The SEC staff issued a no-action letter. It is not
clear whether FERC could interpret ``facilities'' in PUHCA differently
than the SEC Staff. However, the FERC has held that ``facilities''
under the Federal Power Act includes books, records and contracts, and
it has exercised jurisdiction over power marketers on this basis. If
the FERC were given authority to administer PUHCA, I do not know
whether a court would affirm an interpretation of PUHCA consistent with
the FERC's interpretation of the same term under the Federal Power Act.
Question 2. Commissioner Hunt stated that the SEC took into
consideration Enron's ability to get ``into the business'' of power
marketing without a no-action letter. Would the FERC disagree with the
SEC's consideration of the importance of power marketing to competitive
electricity markets?
Answer. I agree that power marketing is important to competitive
electricity markets. Power marketing allows market participants a
greater array of possible transactions, in which the marketer takes
electrical supply from a number of generators and repackages it in the
quantities and with the terms desired by buyers. In short, power
marketing can produce greater efficiencies in the markets.
______
Responses to Questions From Senator Cantwell
Question 1. While I understand, conceptually, how RTOs may provide
benefits to consumers in some regions of the country, you are probably
aware that the Pacific Northwest's situation is quite unique in this
regard, because of the presence of the Bonneville Power Administration
(BPA). BPA is already a centralized grid operator in the sense its owns
about 75 percent of our region's high-voltage transmission system.
Nevertheless, Northwest parties are engaged in vigorous discussion and
working on an RTO proposal that would meet the needs of our region's
consumers. However, I just want to caution FERC that it cannot
prescribe a one-size-fits-all approach to RTOs, and that we need to see
measurable benefits in the Northwest. I believe the Northwest must be
given time to craft an RTO that meets our singular needs--in contrast
to the timeline and concepts outlined in various FERC orders and staff
papers. Do you agree, however, that FERC lacks the authority to direct
a Power Marketing Administration such as BPA to participate in an RTO?
Answer. Yes, I agree that the FERC has no direct authority to
require a PMA such as BPA to participate in an RTO. With respect to BPA
specifically, BPA is overseen by the Department of Energy, and is not
within the Commission's direct jurisdiction under sections 205-206 of
the FPA.
Question 2. With regard to the unregulated nature of forward energy
markets discussed at the Jan. 30 Energy Committee hearing, there are
some of us who are taking a close look at legislative proposals to
close this loophole, which some believe may have allowed Enron--through
its Internet-based trading platform, EnronOnline--to manipulate prices
in the West. What type of jurisdiction and resources do you believe
FERC would need to patrol these markets and apply the same just and
reasonable standard it is currently charged with upholding in other
wholesale market transactions?
Answer. If the Congress finds it appropriate to expand the FERC's
jurisdiction in the way you describe, the legislative language should
give FERC explicit jurisdiction over: (1) derivatives transactions
based on, or reflecting, the prices of or for natural gas or electric
energy; (2) persons making such transactions; and (3) any entity that
operates an electronic facility in which persons make such
transactions. Exceptions from this jurisdiction should apply for any
transactions within the exclusive jurisdiction of the CFTC or the
exclusive jurisdiction of a State over retail sales of natural gas or
electricity. If FERC's responsibilities were expanded in this way, FERC
would likely need significant additional resources.
Question 3. In the wake of Enron's collapse, many merchant
generating companies seem to be in shaky financial condition and,
therefore, are potential buy-out targets. In fact, at least three
proposed power plants in Washington--needed to meet the West's growing
energy demand--have already been put on hold because of this
uncertainty. The weak financial condition of some of these companies
raises concerns. Given that consolidation within the generation sector
is at odds with increased competition, how high should we set the bar
for utility mergers and acquisitions, in order to prevent undue market
power? Shouldn't mergers be deemed ``in the public interest'' before
they are allowed to proceed?
Answer. Mergers involving merchant generation companies generally
require FERC approval under FPA Section 203. (The exception would be a
merger involving only generation facilities and not transmission
facilities or wholesale contracts, a circumstance that occurs
infrequently, if ever.) Under Section 203, proposed mergers must be
``consistent with the public interest'' in order to be approved. Under
existing court precedent, ``consistent with the public interest'' does
not require a showing of positive benefit to the public, but rather a
showing of no detriment to the status quo. The Commission considers the
effect on competition of proposed mergers involving jurisdictional
facilities under the FPA. If the Commission finds that a merger is
likely to harm competition, the Commission may impose conditions on the
merger to prevent such harm. The Commission has used this authority in
past cases to require such procompetitive measures as the filing of an
open access tariff. The Commission also considers the effect of the
merger on rates and on regulation and may impose conditions in these
areas as well. If the Congress were to change the standard under FPA
section 203 to require mergers to be ``in the public interest,'' this
arguably would give the Commission the discretion to require merger
applicants to demonstrate that the merger would increase competition or
result in other positive benefits.
Question 4. S. 1766, the Senate energy bill, relies on FERC access
to books and records to prevent abusive transactions among a utility
holding company's affiliates. Enron reportedly had 5,800 affiliates--
including 281 located off-shore. Given these potentially complex
corporate structures, is access to books and records sufficient to
prevent abusive transactions? Does FERC have the resources to comb
through this massive amount of information?
Answer. Under section 301 of the FPA, the Commission currently has
extensive access to books and records of public utilities and their
affiliates. Increased access to books and records of all members of a
holding company system would provide additional regulatory protection
and sufficient authority to prevent inappropriate affiliate cross-
subsidization. However, FERC may need additional resources to properly
audit books and records. Currently, few FERC personnel have the
experience and training needed to examine and fully analyze the
extremely complex corporate structures and affiliate transactions used
by companies such as Enron. The amount of any additional resources
needed might vary based on any guidance or instructions Congress gives
the Commission along with such new authority. For example, if Congress
requires annual comprehensive reviews of the books and records of all
large utilities, the additional resources needed would be quite
extensive.
______
U.S. Securities and Exchange Commission,
Washington, DC, February 20, 2002.
Hon. Jeff Bingaman,
Committee on Energy and Natural Resources, U.S. Senate, Dirksen Senate
Office Building, Washington, DC.
Dear Chairman Bingaman: Thank you for your letter of February 6th
regarding my testimony before the Committee on Energy and Natural
Resources and transmitting follow-up questions from members of the
Committee. I appreciate the opportunity to respond to the concerns of
Committee members. I ask that you include my responses to these
questions, which follow on the attached pages, in the hearing record.
Please do not hesitate to let me know if I can be of further
assistance.
Sincerely yours,
Isaac C. Hunt, Jr.,
Commissioner.
Responses to Questions From Senator Shelby
Question. Commissioner Hunt, could you please detail for us again,
why the SEC issued a no-action letter with respect to Enron's power
marketing activities? What factors were taken into consideration and
why?
Answer. The no-action letter that Enron Power Marketing, Inc.
(``EPMI'') received stated that the staff would not recommend
enforcement action against the company if it engaged in certain types
of power marketing activities. As a general matter, in a no-enforcement
no-action letter, the staff--not the Commission--agrees not to
recommend enforcement action to the Commission. Typically, as occurred
in this case, the party seeking the letter makes detailed
representations to the staff about the proposed transaction or activity
in question. While the staff usually will not agree or disagree with
the legal analysis set forth by the party, the staff, in issuing the
no-action letter, will base its determinations on those
representations.
In a 1994 no-action letter to EPMI, the SEC staff stated that it
would not recommend an enforcement action under section 2(a)(3) of the
Public Utility Holding Company Act of 1935 (``PUHCA'') in the event
that EPMI, an indirect subsidiary of Enron Corp., entered into
contracts for the purchase and resale of electric power or for
transmission capacity in connection with its power marketing
activities. EPMI did not own any generating plants, transmission lines
or electric distribution systems. EPMI argued in its incoming request
that under PUHCA, the contracts and books and records underlying its
power marketing activities were not ``facilities'' used for the
``generation, transmission or distribution of electric energy for
sale'' and that its power marketing subsidiary therefore was not, for
purposes of PUHCA, an electric utility company subject to the Act. EPMI
also indicated that other companies were engaging in similar power
marketing activities without registering under the Act.
Based on these representations, the staff gave EPMI the requested
no-action assurance.\1\ Although the staff's letter clearly stated that
the staff did not necessarily agree or disagree with EPMI's legal
analysis, the staff would have considered whether, in its view, EPMI
was engaging in activities that were subject to the PUHCA. In deciding
to issue the letter, the staff likely concluded that power marketing
was not a utility activity. Since issuing the no-action letter to EPMI,
the staff has issued approximately 20 analogous letters to other power
marketers. The Commission itself has issued several orders and
promulgated a rule (Rule 58) allowing registered holding companies to
engage in power marketing as a non-utility activity, evidencing its
agreement that power marketing is not a utility activity.\2\
---------------------------------------------------------------------------
\1\ In the past, the staff has noted the potential breadth of the
term ``facility.'' Specifically, in a 1974 no-action letter issued to
Unilease No. 10, Inc., the staff noted that the term could ``include[]
anything which aids or makes easier the performance of the business in
which the company is engaged.'' In that letter, however, the staff also
noted that ``the Act generally distinguishes between the business of a
public utility company and businesses which are nonutilities in
function and character.'' On this basis, the staff concluded that the
``business of fuel procurement, storage and delivery'' was non-utility
in character, and that a company engaged in those activities was not
necessarily a utility company. Therefore, even though the 1974 letter
notes the potential breadth of the term ``facility,'' the result the
staff reached in the EPMI letter is not inconsistent with the result it
reached over 20 years earlier.
\2\ Rule 58, 17 C.F.R. Sec. 250.58, permits a registered holding
company system to engage in various non-utility activities, including
``[t]he brokering and marketing of energy commodities, including but
not limited to electricity, natural or manufactured gas and other
combustible fuels.'' Rule 58(b)(1)(v), 17 C.F.R. Sec. 250.58(b)(1)(v).
---------------------------------------------------------------------------
Question. Could the SEC explain in a more fulsome manner the
import, rationale, and precedent for the order issued in 1997 (Release
No. IC-22560; March 13, 1997) that exempted Enron Corp. from regulation
under the Investment Company Act of 1940? Does this rationale conflict
with that utilized in the 1994 and 1997 no-action letters issued to
Enron under PUHCA? If not, then why not? A brief description of similar
40 Act orders to other energy-related companies would be helpful also.
Answer. As outlined below, the issues underlying the 1997 exemptive
order and the 1994 and 1997 no-action letters were different, and thus
there was no conflict between them. The 1997 exemptive order addressed
whether Enron's participation in foreign infrastructure projects could
lead to it falling within the definition of ``investment company'' in
the Investment Company Act. In contrast, the two no-action letters
dealt with whether a subsidiary engaged in power marketing fell within
the definition of ``utility'' for purposes of PUHCA.
The 1997 exemptive order dealt with Enron's interests in foreign
infrastructure projects in which it believed that it could not acquire
a majority interest for reasons such as restrictions imposed by local
law. The Investment Company Act defines an investment company, among
other things, as any issuer that holds ``investment securities'' in
excess of 40% of its total assets on an unconsolidated basis (exclusive
of cash and U.S. government securities). To the extent Enron's minority
interests in foreign infrastructure projects were ``investment
securities,'' they limited the extent to which Enron could participate
in foreign infrastructure projects without coming within the definition
of ``investment company.''
According to Enron's application for the 1997 SEC exemption
(``Application''), Enron viewed many of its interests in foreign
infrastructure projects as outside the definition of ``investment
security,'' but wanted the SEC exemption to eliminate any uncertainty.
Enron further noted that the Investment Company Act was not intended to
regulate industrial foreign infrastructure activity.\3\
---------------------------------------------------------------------------
\3\ In its June 17, 1996 report on the Securities Amendments of
1996 (the National Securities Markets Improvement Act of 1996), the
House Committee on Commerce stated that it ``expects the Commission to
take administrative action expeditiously, either on a case-by-case
basis through exemptive orders or through rulemaking, to exempt from
regulation as investment companies U.S. companies that own substantial
interests in foreign infrastructure companies and that are directly or
through affiliates actively involved in foreign infrastructure
projects.''
---------------------------------------------------------------------------
Prior to issuing the Enron order, the Commission had granted orders
under section 3(b)(2) of the Act to other companies engaged in foreign
infrastructure projects.\4\ The Enron order extended those orders
somewhat by including within the scope of the exemption smaller, non-
controlling equity stakes in foreign infrastructure projects.
Nonetheless, given the unique limitations sometimes imposed on the
ability of U.S. companies to own large equity stakes in foreign
infrastructure projects, the relief granted Enron was consistent in
principle with the prior orders. In addition, the 1997 order was
consistent with the legislative history of the National Securities
Markets Improvement Act of 1996.\5\ Since that time, the Commission has
issued analogous orders under section 6(c) to four companies, each of
which is involved in foreign infrastructure projects in the
telecommunications area.\6\ Although no other company engaged in
energy-related foreign infrastructure projects has applied for this
type of order, there does not seem to be any reason to distinguish
between energy-related and telecommunications-related infrastructure
projects for purposes of the Investment Company Act.
---------------------------------------------------------------------------
\4\ See CITIC Pacific Limited, Investment Company Act Release Nos.
21282 (Aug. 15, 1995) (notice) and 21375 (Sept. 12, 1995) (order);
Consolidated TVX Mining Corporation, Investment Company Act Release
Nos. 17853 (Nov. 13, 1990) (notice) and 17902 (Dec. 11, 1990) (order).
\5\ See supra note 3.
\6\ See e.g., Propel, Inc., Investment Company Act Release Nos.
24633 (Sep. 6, 2000) (notice) and 24673 (Oct. 3, 2000) (order);
Telesystem International Wireless Inc., Investment Company Act Release
Nos. 23618 (Dec. 22, 1998) (notice) and 23658 (Jan. 20, 1999) (order);
Formus Communications, Investment Company Act Release Nos. 23486 (Oct.
14, 1998) (notice) and 23530 (Nov. 10, 1998) (order); Tele-
Communications International, Inc., Investment Company Act Release Nos.
22797 (Aug. 22, 1997) (notice) and 22825 (Sep. 17, 1997) (order).
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Based on the representations in Enron's application, it does not
appear that Enron would have registered under the Investment Company
Act even absent the 1997 SEC exemption. According to the Application,
if the SEC did not grant the requested exemption, Enron would have
structured or limited its participation in foreign infrastructure
projects so as not to come under the definition of investment company
in the Investment Company Act. An operating company typically finds the
requirements of the Investment Company Act incompatible with its
business needs. It is therefore not uncommon for an operating company
to structure its operations and holdings to avoid falling within the
scope of the Investment Company Act.
Finally, the relief granted Enron under the Investment Company Act
does not conflict with any relief Enron received under PUHCA. First,
there is no relationship between the Investment Company Act relief and
the no-action relief that Enron received from the staff with respect to
its power marketing activities. Second, as I discussed in my testimony,
Enron's global business as portrayed in its exemptive application does
not conflict with Enron's claim of the intrastate exemption under
PUHCA. In administering the intrastate exemption, the Commission has
always looked to the place of incorporation of the holding company, the
place of incorporation of the holding company's utility subsidiaries,
and the states in which those subsidiaries conducted their utility
business. As long as the holding company and material utility
subsidiaries are all incorporated in the same state and the utility
activities are conducted in that state, the holding company is entitled
to the intrastate exemption. The Commission has traditionally held that
the scope and geographic extent of the holding company's non-utility
activities (such as Enron's foreign infrastructure projects) are not to
be considered as part of this analysis. In order to aid the Committee's
understanding of this issue, I have attached to this response a
memorandum prepared by the Division of Investment Management addressing
how the Commission has administered the intrastate exemption since the
enactment of PUHCA.
MEMORANDUM
To: Commissioner Isaac C. Hunt, Jr.
From: Paul F. Roye, Director, Division of Investment Management
Re: The Commission's Historic Approach to the Section 3(a)(1)
``Intrastate'' Exemption
During your February 6, 2002 testimony before the Senate Committee
on Energy and Natural Resources, you were asked a number of questions
about the Commission's approach to the ``intrastate'' exemption
provided by section 3(a)(1) of the Public Utility Holding Company Act
of 1935 (``PUHCA''). These questions may have been related to the
claims of Scott Hempling, another witness, who testified that because
Enron was a global company,, it ``clearly did not meet the requirements
of Section 3(a)(1).'' \1\ Senator Wyden, in particular, expressed
interest in this issue. We have prepared this memorandum to clarify the
Commission's historic approach of under which a holding company's non-
utility activities are not considered in analyzing whether it qualifies
for the intrastate exemption.
---------------------------------------------------------------------------
\1\ Written Testimony of Scott Hempling before the Senate Committee
on Energy and Natural Resources on ``The Public Utility Holding Company
Act of 1935 and S. 1766'' (Feb. 6, 2002) at 31.
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Enron has been an exempt holding company since it acquired Portland
General Electric in 1997. Immediately following its acquisition of
Portland General, Enron was incorporated in Oregon, as was Portland
General, Enron's only ``public utility'' subsidiary. Portland General's
utility operations were conducted almost exclusively within Oregon.
Although Enron engaged in substantial non-utility activities through
other subsidiaries across the United States and internationally, it
claimed exemption under PUHCA rule 2 as an intrastate holding company.
Section 3(a)(1) requires the Commission, ``unless and except
insofar as it finds the exemption detrimental to the public interest or
the interest of investors or consumers'' to exempt any holding company
if:
Such holding company, and every subsidiary company thereof
which is a public-utility company from which such holding
company derives, directly or indirectly, any material part of
its income, are predominantly intrastate in character and carry
on their business substantially in a single State in which such
holding company and every such subsidiary company are
organized.\2\
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\2\ PUHCA Sec. 3(a)(1), 15 U.S.C. Sec. 79c(a)(1).
Under longstanding Commission precedent, holding companies exempt
under section 3(a)(1) have a virtually unlimited ability to diversify
into non-utility activities without any limitation on the geographical
scope of those activities. The leading treatise on the regulation of
utility holding companies states that ``nonutility subsidiaries may be
organized anywhere and . . . the holding company may itself engage in
nonutility activities anywhere.'' \3\
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\3\ Douglas W. Hawes, Utility Holding Companies at 3-12 (1984 and
Supp. 1987).
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This precedent goes back to the earliest days of the Commission's
administration of the Act. Some of these early cases address whether a
holding company's sale of a manufactured product in interstate commerce
puts its exemption at risk. For example, in 1936, the Commission
concluded that a company incorporated in South Carolina with a single
utility subsidiary incorporated and operating in South Carolina did not
lose its entitlement to the exemption because it engaged in interstate
sales of textiles it manufactured through another subsidiary.\4\ The
Commission reached virtually identical conclusions in granting
exemptions to the International Pulp Company \5\ and the Copper Range
Company.\6\
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\4\ In the Matter of Monarch Mills, 1 S.E.C. 822 (1936). The
Commission noted that ``[t]he only interstate activities of the
applicant are in connection with the sale of the textile products of
its South Carolina plants. These sales are effected through New York
commission merchants.'' Id. at 823. The Commission then rejected the
notion that this ``should prevent it from obtaining the exemption under
Section 3(a)(1) to which it would otherwise be entitled.'' Id.
\5\ In the Matter of International Pulp Co., 1 S.E.C. 906 (1936).
\6\ In the Matter of Copper Range Co., 2 S.E.C. 61 (1937). In
Copper Range, the Commission definitively stated that ``this Commission
has indicated in numerous cases that it does not deem that interstate
activities in such non-public utility phases of its business should
prevent the applicant from obtaining the exemption under Section
3(a)(1) to which it otherwise would be entitled.'' Id. at 62.
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The early cases extend beyond the interstate sales of non-utility
subsidiaries incorporated in the same state as the holding company and
make clear that a holding company that owns non-utility subsidiaries
that are incorporated in and operate in different states than the
holding company may also claim an exemption under section 3(a)(1). Most
notably, in 1937, the Commission granted an exemption to the
Southeastern Indiana Corporation.\7\ The company, which was
incorporated in Indiana, owned a single public utility subsidiary,
which was also incorporated in and operating exclusively in Indiana.
The company also owned a number of non-utility subsidiaries
incorporated in Indiana and Ohio that variously provided bus and
telephone service in Indiana, Ohio and Kentucky. In granting the
company's request for an intrastate exemption, the Commission stated
that:
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\7\ In the Matter of Southeastern Indiana Corp., 2 S.E.C. 156
(1937).
[S]uch non-public utility (as defined in Section 2(a)(5))
activities of the applicant do not deprive it of its intrastate
character so far as the public utility aspect of its business
is concerned, and that so long as all of its public utility
subsidiaries are organized under the laws of Indiana and
confine their public utility business to that State, it will be
entitled to the exemption provided by Section 3(a)(1).\8\
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\8\ Id. at 157.
The Southeastern Indiana decision thus made it clear that utility
holding companies could engage in non-utility activities through
subsidiaries incorporated in any state without losing their intrastate
exemption. During the 1940s and 1950s, the Commission granted
intrastate exemptions to companies that engaged in substantial
nonutility activities in other states. For example, in 1945, the
Commission granted an intrastate exemption to a Kansas corporation that
owned two public utility subsidiaries that operated in Kansas and non-
utility subsidiaries that, among other things, were incorporated in and
provided telephone service in Arkansas, Kansas, Indiana, Missouri, New
Jersey, Ohio and Pennsylvania.\9\ The non-utility subsidiaries
represented most of the company's business. The Commission apparently
found it clear ``that such non-utility activities do not deprive [the
applicant] of its intrastate character so far as the public utility
aspects of its business are concerned.'' \10\ Likewise, in 1955, the
Commission granted an intrastate exemption to a Massachusetts
corporation that owned a single public utility subsidiary in
Massachusetts but also owned subsidiaries, some incorporated in other
states, that engaged in substantial coal mining operations (including
activities related to the transportation and distribution of coal, and
the conversion of the coal into gas and other products) throughout the
eastern United States.\11\ Neither the notice nor the order contain any
substantial legal analysis of the claim for exemption, suggesting that
both the Commission and the applicant thought granting the exemption to
be noncontroversial in spite of the applicant's substantial interstate,
non-utility activities.
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\9\ See In the Matter of United Utilities, Inc., Holding Co. Act
Release No. 6045 (Sept. 14, 1945) (order approving the sale of certain
utility assets in Colorado that might have caused the company to lose
its entitlement to the intrastate exemption) (``Sale Order'') and In
the Matter of United Utilities, Inc., Holding Co. Act Release No. 6162
(Oct. 25, 1945) (order granting exemption under section 3(a)(1)). The
Sale Order makes clear that United Utilities' telephone operations
produced over 75% of the holding company's gross revenues.
\10\ Sale Order, supra (citing Southeastern Indiana Corp.).
\11\ See In the Matter of Eastern Gas & Fuel Associates, Holding
Co. Act Release No. 12786 (Jan. 25, 1955) (notice of application for an
exemption under section 3(a)(1)) and Holding Co. Act Release No. 12807
(Feb. 28, 1955) (order granting exemption under section 3(a)(1)).
According to the notice, the company owned subsidiaries in
Massachusetts, Delaware, Virginia, Connecticut, Pennsylvania, West
Virginia, New Jersey and, perhaps surprisingly, a collier incorporated
in Liberia.
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Given the language of section 3(a)(1), it might well have been
within the Commission's discretion to decide these cases in a way other
than it did, and confine the non-utility activities of exempt
intrastate holding companies to the same state in which the holding
company and its utility subsidiaries were incorporated. Indeed, there
are a few aberrational decisions in which the Commission relected
exemptions that seem to fall within this line of precedent.\12\
However, the policy of not looking at the non-utility activities of a
holding company when analyzing its claim to the intrastate exemption
clearly goes back to the earliest days of the Commission's
administration of PUHCA--a time when the individual commissioners who
considered and decided these matters likely were familiar with the
specific details surrounding the enactment of PUHCA and the goals that
Congress was seeking to achieve through the Act.\13\ In this context,
to argue that the Commission is not just abusing its discretion, but is
acting far outside the discretion permitted it, in allowing companies
with substantial interstate non-utility activities to claim exemption
under section 3(a)(1) fails to take into consideration the fact that
the Commission has interpreted the intrastate exemption this way for
over 65 years in a manner consistent with the underlying policy goals
of PUHCA.
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\12\ See Houston Natural Gas Corp., 3 S.E.C. 664 (1938). In Houston
Gas, the Commission appropriately denied the applicant an exemption
under section 3(a)(1) because, although all the applicant holding
company's subsidiaries were incorporated in and operated exclusively in
Texas, the holding company itself was incorporated in Delaware. Id. at
667. However, the decision includes a lengthy discussion in which the
Commission opined that because the company sold its securities in
numerous states and sent interstate mail and made interstate telephone
calls, it was not entitled to the intrastate exemption. Id. at 667-68.
Literally applied, this analysis would deny the section 3(a)(1)
exemption to virtually all companies--it is hard to comprehend how any
company could conduct its business, whether today or in 1938, without
engaging in some interstate administrative activities. The discussion
in Houston Natural Gas is therefore better understood either as
unpersuasive dicta or as an attempt by the Commission to explain why it
mattered, for purposes of the statute, that the holding company and its
utility subsidiaries were incorporated in different states.
\13\ Commissioners during this period included William O. Douglas,
George Matthews, and Robert Healy. James Landis was Chairman of the
Commission from September 1935 through September 1937, the period
during which the earliest of the cases establishing this precedent
under section 3(a)(1) were decided.
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One of the overriding concerns of PUHCA is to give federal
regulators jurisdiction over multistate holding companies that no
single state can effectively regulate. In particular, PUHCA is meant to
ensure that if a state does not have jurisdiction over both the holding
company and the utility that does business in its state--a situation
that will occur if the holding company is incorporated in a state
different than that in which the utility subsidiary is incorporated--a
federal regulator with access to all the holding company's books and
records can step in to monitor and police affiliate transactions.\14\
In general, the Commission has concluded that where the holding company
and all its utility subsidiaries are incorporated in the same state,
this concern does not arise, and an exemption from PUHCA is
warranted.\15\
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\14\ ``It is plain, therefore, that Congress directed the exemption
under Section 3(a)(1) solely to holding companies organized in the same
state as its subsidiaries; it purposely withheld that exemption from
holding companies which control operating utilities in states other
than its domicile . . . in order to assure necessary regulation not
otherwise forthcoming.'' In the Matter of Houston Natural Gas Corp., 3
S.E.C. 664, 667 (1938).
\15\ The Commission retains the authority under section 3 and rules
2 and 6 to revoke an otherwise-warranted intrastate exemption if doing
so is necessary to protect the public interest or the interests of
investors or consumers.
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______
Response to Question From Senator Wyden
Question. I am requesting all records of communications between
Enron Corp. or its subsidiaries or affiliates (``collectively referred
to as ``Enron'') or any representative of Enron and the U.S. Securities
and Exchange Commission (SEC) concerning the Public Utility Holding
Company Act of 1935 or the Investment Company Act of 1940, including
any written, oral, electronic or telephone communication.
Answer. Included with this response are documents responsive to
this request. These documents include applications filed by Enron under
both acts, other materials supplied by Enron to the Commission and its
staff, orders and notices that the Commission has issued with respect
to Enron, Enron's no-action requests and the staff's responses, comment
letters from SEC staff to counsel for Enron, and correspondence from
counsel for Enron to SEC staff. Consistent with our usual practice, we
are not including internal memoranda, handwritten notes, and other non-
public materials that reflect the SEC's deliberations. We also have not
included certain routine filings made by Enron related to its claim of
exemption under rule 2 and notifying the Commission of the status of
certain of its subsidiaries as foreign utility companies or exempt
wholesale generators under sections 32 and 33 of PUHCA. As always, we
would be pleased to answer any further questions Senator Wyden or other
members of the Committee may have with respect to these materials. I
also note that Enron requested confidential treatment under the Freedom
of Information Act for some of the documents that I am including with
my response under separate cover.
______
Responses to Questions From Senator Cantwell
Question. PUHCA Sec. 12(h) prohibits certain political and campaign
contributions by registered holding companies. Has the SEC reviewed the
campaign contributions of registered holding companies and ensured that
no improper contributions are being made? If so, please provide me with
that information. If not, please explain why the SEC has not adhered to
this statutory requirement.
Answer. As you point out, section 12(h) of PUHCA prohibits a
registered holding company from ``mak[ing] any contribution whatsoever
in connection with candidacy, nomination, election or appointment of
any person for or to any office or position'' in federal or state
government. It also prohibits a registered holding company from
mak[ing] any contribution to or in support of any political party or
any committee or agency thereof.''
This provision applies only to registered holding companies. Exempt
holding companies such as Enron are not subject to this prohibition.\7\
With respect to registered holding companies, the Federal Election
Campaign Act clarified section 12(h) to permit the ``establishment,
administration and solicitation of contributions to a separate
segregated fund to be utilized by the corporation for political
purposes.'' \8\ Based upon this amendment, many registered holding
companies have set up PACs to which their employees contribute so that
the corporation can advance its political goals.
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\7\ Exempt holding companies, like all corporations, appear to be
prohibited by the Federal Election Campaign Act from ``mak[ing] a
contribution or expenditure in connection with any election at which
presidential and vice presidential electors or a Senator or
Representative . . . are to be voted for, or in connection with any
primary election or political convention or caucus held to select
candidates for any of the foregoing offices . . . .'' 2 U.S.C.
Sec. 441b(a). The SEC, however, does not administer this statute.
\8\ 2 U.S.C. Sec. 441 b(b)(2) (``For purposes of this section and
section 12(h) of the Public Utility Holding Company Act . . . the term
`contribution or expenditure' . . . shall not include . . . (C) the
establishment, administration, and solicitation of contributions to a
separate segregated fund to be utilized for political purposes by a
corporation, labor organization, membership organization, cooperative,
or corporation without capital stock.'')
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Commission staff regularly examine registered holding companies to
monitor their overall compliance with the Act. Our examinations are
primarily directed at the core abuses that led to passage of the Act,
particularly the provisions governing allocation of costs among system
companies and affiliate transactions between system companies. While
examining for compliance with section 12(h) is not one of our primary
areas of focus, no violations of the section have come to our attention
in recent years. However, as part of the examination program, we do
analyze how the costs of administering PACs are allocated among
companies in the holding company system. This tends to ensure that the
costs of administering PACs are not unfairly allocated to the holding
company's utility subsidiaries. We would obviously take seriously any
allegation that a registered holding company is violating section
12(h).
Appendix II
Additional Material Submitted for the Record
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Statement of the American Forest & Paper Association
The American Forest & Paper Association (AF&PA) appreciates the
opportunity to submit testimony for the hearing record related to the
repeal of the Public Utility Holding Company Act. AF&PA is the national
trade association representing more than 240 member companies and
related associations that engage in or represent the manufacturers of
pulp, paper, paperboard and wood products. America's forest and paper
industry ranges from state-of-the-art paper mills to small, family-
owned sawmills and some nine million individual woodlot owners.
The forest products industry is a major energy producer and
consumer, producing nearly 60 percent of its own power, largely though
the use of biomass. At some paper and wood manufacturing facilities,
self-generated electricity goes beyond serving onsite production needs
by providing supplemental electricity to the surrounding electric power
grid.
We support comprehensive electricity legislation that promotes
competition in the energy markets. However, until there is a truly
competitive marketplace, we have concerns about the vacuum that may
exist if PUHCA is repealed without adequate safeguards put in its
place. Therefore, we offer the following suggestions as possible ways
to ensure that a competitive market can take hold in the context of
efforts such as S. 1766 to promote competition in the electricity
marketplace.
puhca and related market power issues
PUHCA was originally designed to break up ``the unconstrained and
excessively large trusts that then controlled the Nation's electric and
gas distribution networks.'' It was intended to be an effective
safeguard against market power abuses by utilities and their affiliates
that evaded regulatory oversight through complex holding company
arrangements.
The current enforcement under PUHCA is not effective. The
Securities and Exchange Commission has openly admitted that it has done
a poor job at enforcing provisions of PUHCA. But market power issues
are still extremely important, particularly in states that have no
retail competition. The development of a fully functioning competitive
electricity market (wholesale and retail) cannot take place if
utilities, whether they be investor-owned, federal, municipal or
cooperative, are allowed significant government-sanctioned advantages
over their competitors.
PUHCA should not be repealed before the establishment of a fully
functioning competitive market (wholesale and retail) for electricity
throughout the nation. However, should the Congress decide to proceed
with PUHCA repeal legislation, then steps need to be taken to ensure
that implementation of such legislation coincides with the effective
operation of truly competitive electricity markets. At a bare minimum,
the repeal date of PUHCA for a utility should be linked to the date
that the FERC certifies that markets served by that utility are open
and competitive. The relevant market should be defined as a large area,
such as that covered by an RTO.
AF&PA would support the repeal of PUHCA under the following
conditions that would apply to both public and private power:
Legislation is enacted requiring participation in Regional
Transmission Organizations (RTOs) by all transmission entities.
This legislation must set a firm deadline for RTO
participation, give the FERC adequate authority to implement
RTOs, and be effective only upon the full and efficient
functioning of the RTOs.
Markets administered by RTOs are fully functional and
workably competitive.
Legislation is enacted that (i) requires FERC to act on a
complaint regarding the abuse of market power within 90 days of
the filing of the complaint, (ii) failing timely action by
FERC, allows the complainant to seek redress from the Federal
Trade Commission, and (iii) allows such complaints to be
initiated by consumers and other market participants.
Legislation is enacted that provides explicit criteria
(e.g., market concentration, scale, etc.) for the merger or
acquisition of regulated entities, and requires clear and
significant economic benefits to ratepayers as a condition of
approval.
Legislation is enacted that (1) provides access to the books
and records of holding companies by state commissions and (ii)
limits the pass-through to captive retail ratepayers by
regulated utilities of costs incurred by their marketing
affiliates only to those costs that serve the ratepayers and
that are either cost-based or shown to be competitive in a
fully functioning competitive market.
Absent a nationwide, fully functioning competitive retail
electricity market, implementation of PUHCA repeal only upon
certification by the FERC that the markets served by the
utility are fully functioning and competitive.
We appreciate the opportunity to submit these suggestions related
to PUHCA repeal and look forward to working with the Committee and the
full Senate as this issue moves through the legislative process.
______
Statement of the Executive Intelligence Review
enron: the convergence of energy and financial deregulation, and the
end of the off-balance-sheet era
With every day that passes, it becomes more obvious that Enron was
a thoroughly corrupt corporation, which cooked its books through a
variety of schemes, including the use of special purpose entities and
off-balance-sheet partnerships. As a result of these machinations,
Enron presented a completely false face to the public--it was a
financial scam, masquerading as an energy company.
At this point, few would argue that Enron was out of control,
operating well outside the bounds of ethics and apparently outside the
law, and few would argue that those officers and directors of Enron, as
well as its accountants and lawyers, should be held accountable for
their actions, or the lack thereof.
There is another group which should be held accountable, and that
group includes the policymakers who have systematically stripped away
the body of protections which had been written into State and Federal
laws and regulations, in order to keep the Enrons of the world in
check.
Lyndon LaRouche, the founding editor of EIR News Service, has both
through this news service and through his role as a pre-candidate for
the 2004 Presidential election, led the mobilization against energy
deregulation, focusing the attention of California, the nation and the
international community on the destructive nature of deregulation, and
the key role Enron has played in that process. LaRouche has also led
the fight against the out-of-control speculation in the derivatives
markets, where Enron also played.
The Enron debacle now gives Congress, and this Committee, the
opportunity to re-visit the nation's approach to deregulation, to
confront and correct the errors which are destroying out nation's
economy. It is an opportunity which should not be wasted.
Beyond the Culture of Corruption
The ``culture of corruption'' which thrived at Enron is nothing
new; history is replete with similar examples of untrammeled greed, and
of the need to protect populations from that greed. The strength of our
nation is based in part on the creativity of our people, and for that
creativity to flourish, the public must be protected from exploitation.
Creativity is the rising tide which lifts all boats, but those boats
must also be protected from pirates.
In its investigation of the Enron affair, the Congress must look
not just at the company, but at the environment in which the company
operated. In this case, that means looking at how deregulation created
the conditions under which Enron's activities became possible.
One of the founding principles of the United States, is that the
Government has not just the right, but the duty, to advance and protect
the General Welfare of the People. In the wake of the Great Depression,
a number of laws were passed to protect the People from abuses;
prominent among them the Glass-Steagall Act, which was designed to
prevent financial insiders from profiting at the expense of the general
public, and the Public Utilities Holding Company Act, which was
designed to protect the People from the machinations of the giant
Morgan and Insull electricity cartels, whose holding company structures
were in many respects the equivalents of today's off-balance-sheet
structures. Congress passed these laws because events proved them
necessary--they were necessary then, and they are necessary today.
Over the years, most of the protections implemented during the
Roosevelt era have been stripped away. Glass-Steagall was gutted, then
repealed, and an already weakened PUHCA is facing a similar fate unless
wiser minds prevail. The combination of energy deregulation and the
surge in mergers among regulated utility holding companies has created
an environment in which the electricity market is increasingly coming
to resemble the casino mondiale financial markets.
Enron, in many respects, reflects the deadly convergence of
financial and energy deregulation. In its S.E.C. filings, Enron
described itself as an investment bank, and testimony before this
Congress has detailed the extent to which Enron was a derivatives
trading firm rather than an energy company. What Enron was doing was
applying to the deregulated energy markets, the same kinds of
speculative derivatives trading that the big investment and commercial
banks--a distinction which is fast disappearing--have long applied to
the deregulated financial markets.
In its off-balance-sheet activities, Enron was following a trend
which began in the banking world. Until recently, every issue of the
Federal Deposit Insurance Corporation's Quarterly Banking Profile
contained a line item for ``off-balance-sheet derivatives,'' The
F.D.I.C. has discretely dropped the ``off-balance-sheet'' portion of
the designation, but the derivatives remain, $51.7 trillion of them,
backed by $6.6 trillion in assets and $586 billion in equity capital. A
loss equivalent to just 1.1% of the total derivatives portfolio would
be sufficient to wipe out the entire equity capital of the U.S. banking
system.
The most egregious example of derivatives speculation is J.P.
Morgan Chase & Co., which by itself has a $24 trillion derivatives
portfolio, roughly half of the total derivatives held by all U.S. bank
holding companies. That figure is as of the third quarter, at which
point Morgan Chase reported assets of $799 billion and equity capital
of $42.7 billion. meaning that a loss equivalent to less than 0.2% of
is derivatives portfolio would wipe out its equity base. At Citigroup
and Bank of America, which between them have another $18 trillion in
derivatives, it would take only 0.5%.
These aren't banks any more than Enron was an energy company.
Enron's reported $200 billion derivatives portfolio pales by comparison
to the holdings of the big banks, but Enron was just getting started.
The big banks were already involved in energy trading, and with Enron's
demise have strengthened their position in the market.
The extraordinary danger presented by such derivatives speculation
is clear in the Enron case, where derivatives were used to hide the
company's condition, but again, this is just a case of Enron following
the example of its banking peers, as investigations by the Japanese
Government have brought to light numerous examples where Wall Street
firms employed derivatives to help Japanese companies hide losses.
Derivatives were also at the root of the 1998 failure of Long-Term
Capital Management, and the wave of derivatives losses which swept the
country in the early 1990s. The shocking $105 billion drop in assets at
Morgan Chase during the fourth quarter suggests that the derivatives
losses have not gone away, but are just better hidden in a complex of
off-balance-sheet structures of the type we see in the Enron case.
Had Congress and the States not dismantled the nations regulatory
protections, there would be no need for these hearings. This hearing
provides the Senate with the opportunity to return to a policy of sound
regulation in the public interest. PUHCA must be strengthened, not
weakened, as the first step in rolling back deregulation. Congress must
choose between servicing the casino at the expense of the population,
and protecting the General Welfare by rebuilding the protections which
have been stripped away.
The Energy Committee, in particular, has the responsibility of
``picking up the pieces'' from the ``Enronomics'' era so that the
nation may begin to reverse the damage done by deregulation. As
LaRouche outlines in his forthcoming special report ``At the End of a
Delusion,'' we can build our way out of this deepening global
depression, if we chose to do so, but it requires the courage to admit
that we must abandon the policies which have created this disaster.
LaRouche outlined the measures which are required in the energy
realm in an international Webcast on Jan. 24, 2002, in an exchange with
State Sen. Joe Neal (D-Las Vegas), a senior Nevada lawmaker, who
successfully led the fight against deregulation, and against Enron, in
his state, and also in other states and in Mexico.
In response to Neal's question about the reasons for the collapse
of Enron and what it means for the country, LaRouche responded:
I would go backwards, and go from the end-result of the crash
of Enron, rather than trying to, say, re-write the history of
what Enron's history should have been.
First of all, we face a major energy crisis in the United
States. The severity of this crisis is hidden by the fact of
the collapse of our industries. If we were to rev up the
economy overnight, we couldn't support it.
People don't realize that we have been exporting our
industries, in shutting down whole sections of the functions of
our economy, we have lowered the requirement of energy! If we
were to try to restore the economy, to what it was at, say,
1980 or earlier, we would have to have a large amount of new
energy.
So, therefore, we have the need for a national energy
recovery program, which would cover, inclusively, the problems
which are illustrated by and posed by Enron, and similar
institutions. That means that we have to repeal deregulation;
go back to the system of regulation, we used to have: I think
we'd just go back to that; that's adequate, because it would
work: There're are precedents; the machinery is all
understood--it would work; just do it.
But, set, also, into motion--See President Bush is trying to
find out ways of stimulating the economy, and he doesn't know
how to do it. Well, this is one of the ways of doing it. If you
take Federal money, and use it, not just as Federal printed
money, but Federal credit; and you put it into a national
energy program, which is going to fix the national energy grid
system, to make it more usable and to improve its performance:
That, in itself, is a good way to make the economy grow. And,
it's typical of the various measures, which government can
take, which are largely in the area of infrastructure and
special projects; not in the private sector, as such, but in
those areas alone, which will cause the economy to grow.