The CHAIRMAN. Senator Faircloth.

Senator FAIRCLOTH. Mr. LoBaugh pretty much answered what I was going to ask, about the firewall or whatever between the utilities and the outside ventures.

Out of curiosity, which did you lose the most money on?

Mr. LOBAUGH. Drug stores.

Senator FAIRCLOTH. Drug stores? I would have thought farming. [Laughter.]

Mr. LOBAUGH. No. Ironically, in farming, we made money. At one point, we even had an immense amount of the world's population, the production of pistachio nuts. We never made any money there, however. But in the rest of the area, we did make substantial money.

We got out of farming for a variety of reasons. The return wasn't that great, there were some environmental concerns, and as the issues associated with the labor movements, et cetera, started to rise in California, the board directed us to liquidate or sell the farming assets. We did so at a profit.

Senator FAIRCLOTH. You say you did not raise rates. Without this outside loss, businesses beyond your utility, normal business, could you have reduced rates if you had not had a $1 billion loss?

Mr. LOBAUGH. No. They had nothing to do with the rates of the utility. The utility rates in California start with the basic investment in the utility plant. You receive your debt cost. You receive a proposed return on that.

The gas costs, per se, are basically flow-through costs. You have your O&M charges that are associated with the operation and outside contracts.

Any inter-affiliate transaction, which for us was primarily those of corporate services such as the lawyers, are examined by the commission. They even go so far as to check our timesheets. We keep timesheets for every 15 minutes, like a law firm would, and those are reviewed and audited and the costs are checked.

So, no, it had no impact and would not have had any impact on the utility.

I think there's a perverse incentive where capital is not available for utilities to go elsewhere, though. I'm not familiar with any utilities that have done this, but I've read that there is an incentive to reinvest capital back in the utility, if that's your sole place for earning.

The name of the game before competition was basically the idea that you enlarged your rate base. The more capital you funneled back into that utility, the more earnings the corporation achieved. There is a perverse incentive there that is inconsistent with one of the comments made by the earlier commentators.

The CHAIRMAN. Dr. Cooper is going wild now.

Dr. COOPER. Let me make a positive suggestion.
Senator FAIRCLOTH. Just a minute.

In running the State utility commission, we found that happening a great deal of the time, excess spending in the utility because the more they spent, the more they got back. I followed that practice for 7 years.

Thank you.

The CHAIRMAN. Dr. Cooper.

Dr. COOPER. California is a State with a fairly potent holding company law. It might do the Committee well to look at the potency of that law because I guarantee you, the other 49 States, not all of them are there. Actually, most of them are not even close.

If we are going to invoke these tremendous powers of California as the backstop, the answer is to have those protections elsewhere. California is a pretty big commission with lots of resources and gets after its utilities.

Second of all, this question of the $1 billion loss, where did the capital come from? It probably came from the cash-flow generated by the operating companies.

One of the things that happens, particularly within telephone companies and also within exempt holding companies, if you generate all of this free cash-and that's what it's called in the banking community-if you can't bury it somewhere, if you can't buy drug stores and so forth, it starts to build up within the utility.

What tends to happen is you declare very fat dividends and regulators suddenly discover, hey, maybe rates are too high because the total return to investors start to go real big if you can't shovel cash out the door somewhere else.

You can say this was cash generated by the operating company, but it was returned of and on capital and therefore, it had no effect on rates. If you can't funnel it somewhere else, it has this tendency to embarrass regulators because it builds up, increasing a return.

One of the problems of divestiture, and it's quite clear in the telephone industry, is the operating companies have been generating humongous sums of cash that have been funneled out into unregulated businesses. Then we complain that, if that opportunity hadn't been there, our rates could have gone down.

Mr. MEYER. That is a basic misunderstanding of the economic system.

The CHAIRMAN. This is a wonderful debate.

Mr. MEYER. That cash belonged to the shareholders, who got it back and hopefully, by installing management, management will decide what will be invested, Dr. Cooper.

Dr. COOPER. Under a regulated utility, you have a return which must be reasonable commensurate with risk. If there is too much cash generated, then rates are too high and ought to come down.

The CHAIRMAN. But, Dr. Cooper, isn't that really one of the problems inherent in a monopoly system, where franchises are granted and where you do have the regulation of capital return?

In fairness to your observation, I think you make a good point. But these are broad issues and problems with regulated monopoly systems.

I don't know how to solve these problems, and I think they are part of the big picture of energy deregulation, but they are undeniably issues that need answers.

Dr. COOPER. The mixed enterprise is what creates the problem, partially regulated, partially unregulated, and how the cash flows within that.

The CHAIRMAN. Senator Faircloth stated this problem well-and I saw it for years in the State of New York, where the regulated utilities did not care and poured more and more and more money into their affiliates because they got their return from the State

based on the profit of the core business. That's how that Shoreham monster came about.

If the public service commission in New York did not grant rate increases based on core business profit, LILCO would have never put billions and billions into that monster.

So the system encouraged that kind of situation. You are right, until the rate system changes or there is true competition, there will be an incentive for utilities to minimize the rate of return.

Let me say this to you, because we could continue this debate all day, that while the concerns you raise are reasonable, they belong to the broader debate on energy deregulation.

I also want to say to Dr. Cooper, Mr. Frimerman, and Mr. Tanski, that I would welcome your input as it relates to suggested legislative proposals to make S. 621 a better bill. I'm not saying we will take all the suggestions, but we are interested in looking at anything you have to offer. Both the Majority and Minority counsels are working on this. This is a bipartisan effort with broad support.

I want to say, again, that I would like to move this quickly. I know there are Members of this Committee who feel much stronger than I do with respect to this legislation. But I would like to see that the legitimate concerns on all sides are addressed so that this bill is as strong as possible as it moves forward.

I would suggest you contact the Committee counsels. They stand ready to meet with you.

I thank all the witnesses for participating today, and we welcome your suggestions.

Senator Faircloth, do you have any final comments you would like to make before we adjourn?

Senator FAIRCLOTH. No. Thank you.

The CHAIRMAN. We stand in recess.

[Whereupon, at 12:00 noon, the Senate Banking Committee was adjourned.Î

[Prepared statements, response to written questions, and additional material supplied for the record follow:]

PREPARED STATEMENT OF SENATOR ALFONSE M. D'AMATO Later this week, this Nation will unveil a new monument to a great New Yorker and former President, Franklin Delano Roosevelt. As father of the New Deal, FDR's legislative legacy has dominated America for the last 60 years. Now, as we stand on the edge of the new millennium, it is time to rethink laws which no longer meet the test or needs of modern times. As we celebrate a new structure on the Mall, it is now time to reform an old one-the structure of public utility holding company regulation.

Today the Committee will consider reform of the Public Utility Holding Company Act of 1935; including S. 621, the "Public Utility Holding Company Act of 1997." This bipartisan bill is identical to legislation the Committee reported last Congress. S. 621 would repeal PUHCA and would eliminate the SEC's role as the primary regulator for 15 registered public utility holding companies, giving that regulatory authority to the States and to the FERC.

As both the Chairman and Ranking Member of the Senate Energy Committee Senators Murkowski and Johnston-testified last year, PUHCA repeal is necessary "to streamline regulation, promote competition, and protect utility customers." I would like to thank Senator Murkowski for appearing before this Committee again this year.

S. 621 would accomplish two critical goals—it would improve consumer protection and make the energy industry more competitive.

The bill would improve consumer protection by making it easier for State and Federal regulators to make sure consumers don't pick up the tab for expenses that have nothing to do with the energy services they receive. S. 621 would ensure that utility companies set fair rates by allowing the regulators to have more access than they have today to inspect the books and records of the utility company and all of its affiliate companies.

Transferring all regulation of utility holding companies to the energy regulators would consolidate regulation, making the regulators more efficient and effective. It would also streamline regulation for registered utility companies and create a level playing field between registered and exempt holding companies.

Overall, S. 621 creates a better and less burdensome system benefiting both consumers and businesses. S. 621 would knock down antiquated barriers to competition and facilitate deregulation.

The States have already taken steps to deregulate the energy industry. My own State of New York approved a plan for deregulation last year. The plan allows New Yorkers who pay some of the highest electricity rates in the country-to choose their power provider, just as they can choose their long distance telephone company. More competition will ultimately mean cheaper rates for consumers.

While my distinguished colleagues on the Energy Committee continue their work on a comprehensive energy bill, PUHCA repeal can and should go forward now.

As FDR once said, "There is nothing I love as much as a good fight." I have been fighting to reform PUHCA for many years and I thank my colleagues for joining me in this fight. I thank the cosponsors of the bill, Senator Murkowski, from the Committee on Energy and Natural Resources, and on this Committee: Senators Dodd, Sarbanes, Gramm, Shelby, Mack, Faircloth, and Allard.

S. 621 represents a bipartisan effort, developed in consultation with State and Federal regulators and the private sector. I hope that today's hearing will enable the Committee to report soon a bill that protects customers and is good for business. I look forward to hearing the witnesses testimony.

PREPARED STATEMENT OF SENATOR CHRISTOPHER J. DODD

Thank you very much, Mr. Chairman, for scheduling today's hearing on S. 621, the Public Utilities Holding Company Act of 1997. I am very pleased to be an original cosponsor of this legislation which, when enacted, will remove some archaic and unnecessary barriers to competition in the energy industry.

There is little doubt that "PUHCA” is one of the more obscure laws under the jurisdiction of this Committee, yet it's important to recognize that when it was originally enacted, in 1935, it was one of the most important securities laws created as part of the New Deal reforms that followed the financial catastrophes of the Great Depression.

Nor should we forget that PUHCA was enacted primarily as investor protection law, not as rate-payer protection law. That's why administration of the statute was placed and kept within the Securities and Exchange Commission, rather than in the FERC's predecessor, the Federal Power Commission.

Today, many of PUHCA's requirements have been rendered obsolete by the success of other Federal securities laws and by the successful regulation of the energy industry by State and Federal authorities. Of course, at the time PUHCA was enacted, over 60 years ago, these other statutes and regulatory bodies were either in their infancy or did not even exist.

In light of the maturation of both securities and utility regulation, it is now appropriate to ask ourselves if the specific restrictions contained in PUHCA are still

necessary.

Careful consideration of the issue leads me to agree with the SEC that the answer is “no.” That is why I am very pleased to be an original cosponsor of S. 621, which will repeal the archaic sections of PUHCA and transfer regulatory authority over the remaining utility holding companies from the SEC to the FERC, where it rightly belongs.

Let me cite just one provision of PUHCA that demonstrates how anachronistic this law has become. Unlike any other industry in America, the registered holding companies were required to seek SEC approval before they issue or sell securities. This is clearly an outdated and unnecessary statutory provision-which applies to no other group of companies in the country. While the SEC has long recognized, through regulatory action, that this is an outmoded requirement, it is high time for Congress to arrive at the same recognition and remove from the books these statutory restrictions that made sense in 1935, but make little sense today.

Mr. Chairman, the legislation under consideration today is the result of a diligent effort by this Committee to work with the SEC, the FERC, and State utility commissioners to fashion a bill which would first ensure that the FERC and the States maintain all the tools necessary to fully regulate the utility holding companies while eliminating the barriers to competition.

Last year, the result of that effort, S. 1317, was passed by this Committee with the support of all three of those regulatory bodies no mean feat. S. 621 is virtually identical to that legislation and I hope that we can move with all due speed to a markup of it.

I would like to address one final point, Mr. Chairman, before we turn to our three panels of distinguished witnesses.

Ever since we embarked on this effort to repeal PUHCA, my office has heard from those interests who, while expressing no substantive disagreement with the legislation, urge this Committee to delay action until such time when Congress considers a gargantuan energy deregulation bill. Those interests see PUHCA repeal just as a bargaining chip they can use to extract concessions on issues that fall outside the jurisdiction of our Committee.

I, for one, have never been a fan of making the enemy of the good; nor am I supportive of failing to take one significant step forward in the hope of trying to leap a record 20 steps forward instead.

Mr. Chairman, I believe the evidence and the hearing record will clearly demonstrate that there are ample regulatory and statutory structures in place to fully protect both investors and rate-payers without forcing these companies to endure the expense and burden of complying with this outdated statute.

I applaud you for pushing this initiative, and look forward to working with you on its eventual passage.

PREPARED STATEMENT OF SENATOR WAYNE ALLARD

Thank you, Mr. Chairman, for holding this important hearing on the conditional repeal of the Public Utilities Holding Company Act. As you know, I am a cosponsor of this legislation. This legislation does what we need to do more, it consolidates regulation and eliminates duplication. But it is also important to point out that this legislation retains many consumer protections.

The Securities and Exchange Commission, the agency which enforces this Act, recommends that this legislation be approved. This is instructive, since it is so rare that a Federal agency recommends that its regulatory authority be curtailed.

I mentioned that this legislation constitutes conditional repeal. Under the legislation, much of the authority held by the SEC is transferred to the Federal Energy Regulatory Commission (FERC) and to the State utility regulators. The SEC already defers to the FERC for the key decisions under PUHCA.

I know there is opposition to this legislation. However, this opposition appears to focus on the timing and the context of repeal.

I am sure there may be ways to improve this legislation, and I look forward to working with the Chairman in this process.