RESPONSE TO WRITTEN QUESTIONS OF SENATOR D'AMATO FROM ISAAC C. HUNT, JR. Q.1. How much authority to approve the acquisitions, the mergers, and diversification by utility holding companies does your agency exercise? What are some of the things your agency considers in reviewing these transactions? Do you look at market power issues in approving acquisitions? A.1. The SEC has comprehensive authority over the utility and non-utility acquisitions of registered system companies and acquisitions by other parties that result in utility affiliations. Section 9(a) of the Public Utility Holding Company Act of 1935 (1935 Act) requires SEC approval of (1) an acquisition of securities or utility assets, or any other interest in any business, by a registered holding company and its subsidiaries,1 and (2) an acquisition of utility securities by any person if that person is, or would thereby become, an affiliate of more than one utility company.2 These requirements duplicate other regulation at both the Federal and State level in some important respects.3 Section 10 of the 1935 Act requires the SEC to consider a number of factors and issues in determining whether to approve these transactions. The following standards of the 1935 Act apply to review and approval of the transactions mentioned above: (i) Acquisition of securities or utility assets: Section 10(a) specifies the information to be included in an application for approval of these transactions. Section 10(b) requires that, if applicable State laws are complied with, the SEC will approve an acquisition unless it finds that: • The acquisition will tend toward interlocking relations or the concentration of control of utilities detrimental to the public interest or the interest of investors or consumers; • The consideration and fees paid in connection with the acquisition is not reasonable or is not fair in relation to the sums invested or the earning capacity of the assets to be acquired; or • The acquisition will complicate the capital structure of the system or be detrimental to the public interest or the interest of investors or consumers or the proper functioning of the holding company system. 1 Section 9(a)(1) of the 1935 Act. 2 Section 9(a)(2) of the 1935 Act. An "affiliate" is defined under section 2(a)(11) of the 1935 Act as any person that directly or indirectly owns 5 percent or more of the outstanding voting securities of a public utility company. 3 The Federal Energy Regulatory Commission (FERC) has jurisdiction to review and approve any sale, lease, merger, or consolidation by utilities of jurisdictional facilities and any acquisition by a utility of securities of another utility, Federal Power Act, §824b, and its review largely parallels the review by the SEC. A very substantial number of State commissions also have jurisdiction over combinations of utility companies, through authority to review mergers and/or acquisitions of utility assets and securities. According to a survey of the National Association of Regulatory Utility Commissioners, conducted in conjunction with a June 1995 staff report of the SEC's Division of Investment Management on the future of utility holding company regulation, 33 of the 43 commissions responding to the question indicated that they have jurisdiction over utility mergers; 30 of 43 respondents stated that they regulate acquisitions of utility assets; and 35 respondents indicated jurisdiction over utility acquisitions in at least some factual situations. Fewer States have prior approval authority over non-utility diversification: In a telephone survey following up on responses to the NARUČ survey, 12 of a total of 43 State commissions responding indicated that they have jurisdiction over diversified activities of utilities in addition to the ability to disallow diversification costs and losses in the context of rate-making. Section 10(c)(1) further provides that the SEC may not approve an acquisition which would contravene certain State laws with respect to ownership of combination gas/electric utilities, or that would be detrimental to carrying out the provisions of section 11, including the requirement that the operations of a registered holding company system be limited to a single integrated utility system and certain additional systems and incidental businesses. Section 10(c) also requires the SEC to find that a proposed acquisition will serve the public interest by tending toward the economical and efficient development of an integrated utility system. (ii) Acquisition of interests in "other" businesses: Non-utility acquisitions are also subject to the relevant standards of section 10, discussed above, including the requirement that the acquisition not be detrimental to carrying out provisions included in section 11. Section 11 of the 1935 Act limits the "other," i.e., non-utility, businesses in which a registered holding company and its subsidiaries may engage to those that are "reasonably incidental, or economically necessary or appropriate" to the operation of the integrated utility system, on a finding that they are "necessary or appropriate in the public interest or for the protection of investors or consumers and not detrimental to the functioning of such system or systems."5 The Commission interpreted these provisions strictly in the early years of its administration of the 1935 Act, to carry out the statutory purposes.6 In recent years, the Commission has construed section 11(b) more expansively, consistent with the statutory purposes, in response to changes in the utility industry.7 With respect to the issue of market power, the possibility of increased utility merger activity after repeal of the 1935 Act was considered in arriving at the 1995 staff report's recommendation to repeal the statute. The 1935 Act does provide an additional layer of regulatory approval for certain utility mergers which may act as a disincentive to some business combinations or attempted takeovers. The report concluded, however, that this layer of approval is no longer needed. As noted above, the FERC also has jurisdiction to review some utility mergers and acquisitions. In some cases, the matters reviewed by the two agencies overlap and separate consideration of these matters by each would be duplicative. Both the SEC and the FERC consider, among other things, the effect of the proposed transaction on competition.8 In recent years, the SEC has looked to the FERC's analysis of issues which are closely linked to oper 4 Section 2(a)(29) defines an “integrated public utility system" separately for gas and electric systems. In general, the definitions speak in terms of geographic integration and coordination of operations and, in the case of electric systems, physical interconnection. 5 Section 11(b)(1) of the 1935 Act. The language cited is that of the so-called "other business" clauses. 6 As the June 1995 staff report notes, unsuccessful diversification was one of the factors that led to the financial difficulties of many holding companies prior to enactment of the 1935 Act. 7 Many activities that are classified as "other" businesses under the 1935 Act are becoming integral parts of the modern utility business. For instance, the marketing and brokering of energy commodities, and the provision of energy and demand side management services, have become important components of utility operations and, as such, have been approved by the SEC in many cases. See, e.g., New England Electric System, SEC Release No. 35-22719 (Nov. 19, 1982), Consolidated Natural Gas Co., SEC Release No. 35-26512 (April 30, 1996), and SEI Holdings, Inc., SEC Release No. 35-26581 (Sept. 26, 1996). 8 As noted above, under section 10(b)(1) of the 1935 Act, the SEC must consider whether a proposed merger or acquisition would tend toward interlocking relations or the concentration of control of utilities detrimental to the public interest or the interest of investors or consumers. ations, including issues that are related to competitive effect and market power, and has deferred to the FERC's expertise in this area. Moreover, the possible anti-competitive effects of proposed utility mergers are also reviewed by many States 10 and by the Department of Justice and the Federal Trade Commission. The SEC often confers with these entities on issues related to competitive effects of proposed transactions. The June 1995 report recommended that the SEC continue to "watchfully defer" to the substantive findings of other agencies in appropriate cases. Q.2. The Federal Energy Regulatory Commission has stated in testimony that they do not need, nor want, additional authority to conduct prior approval of affiliate transactions. Considering the FERC's position, do you think it is necessary that the legislation include this additional authority? A.2. The Commission continues to believe that some Federal oversight of affiliate transactions among companies in holding company systems may be needed to prevent abuses. Upon repeal of the 1935 Act, companies in holding company systems may, depending on applicable State law, be freer to acquire interests in diversified businesses. If this should occur, a greater number of non-utility companies in holding company systems may sell goods or services to their sister utility companies. Because we cannot predict the nature and extent of these services, some of which may go far afield from the traditional utility business, the SEC continues to support giving the FERC the ability, though not the obligation, to take a closer look at these transactions in appropriate circumstances. We recognize, however, that the FERC will be the agency charged with administration of the new Holding Company Act, and we defer to its judgment as to the tools it will need in order to fulfill its regulatory responsibilities. Q.3. In your opinion, what are the effects of this legislation on the ability of companies, States, and Federal regulators to restructure as the energy industry moves toward competition and deregulation? What would be the effect on energy deregulation in general, and on the registered holding companies specifically, if PUHCA is not repealed? A.3. Utility industry deregulation and restructuring are creating novel issues under the 1935 Act. Formation of "independent system operators" to operate transmission grids throughout the country is underway, 11 various State initiatives encouraging customer choice and separation of generation assets from other utility property are being considered or implemented, 12 alternative energy suppliers are participating in increasingly competitive energy markets, and 9 See, e.g., Cinergy Corp., SEC Release No. 35-26146 (Oct. 21, 1994); and Entergy Corp., SEC Release No. 35-25952 (Dec. 17, 1993). 10 See note 3 above. 11 Formation of these entities is encouraged by FERC Order No. 888. 12 See, e.g., "California to Let Small Customers Pick Their Power Suppliers in '98," New York Times (May 7, 1997), at D1 (California expedites plan to allow customers to choose electricity suppliers); and Rhode Island Utility Restructuring Act of 1996, discussed in "R.I. Gov. Almond Signs Nation's First Bill Establishing Retail Wheeling," Electric Utility Week (Aug. 12, 1996) (discussing State legislation that calls for retail choice and for "corporate unbundling to create a firewall between utility affiliates"). utilities are beginning to separate the regulated and competitive portions of their utility business. The 1935 Act was not written in contemplation of the types of activity that are taking place in the 1990's: It reflects a model of vertically-integrated monopolies, and its core definitions can operate in unexpected ways as the industry departs from this model. These developments raise issues concerning the need for registered holding companies to obtain approval to restructure their operations and engage in new utility-related activities, and the integration of their utility properties after restructuring. They also raise questions concerning the status of various industry participants as utilities and holding companies. A "public utility company" under the 1935 Act, for example, includes any entity that owns or operates facilities for the distribution of gas at retail or facilities for the generation, transmission, or distribution of electric energy for sale. A "holding company" is defined to include an entity that has at least a 10 percent or more voting interest in a public utility. Under these definitions, absent an available exemption, the entity that holds title to the relevant physical assets, such as a generating company, is technically a utility under the 1935 Act, even though it may not sell electricity or gas, and its parent is technically a utility holding company, each potentially subject to the full range of regulation under the 1935 Act. 13 The very same result holds for an entity such as an independent system operator that operates, but does not own, the physical assets. At the same time, the actual seller of the energy commodity itself, if it owns or operates no facilities, may escape the 1935 Act regulation. The staff of the Commission has generally concluded that despite its contracts for the sale of gas or electric power, an energy marketer is not a public utility under the 1935 Act. 14 Issues concerning the scope of permissible activities, and the effect of additional activities on non-utility status of a marketer, continue to arise. The interplay of the 1935 Act with restructuring initiatives is expected to be a major focus of applications and interpretive questions in the coming years. It is difficult to predict the ways in which the 1935 Act could apply to or impede these restructuring developments, which participants in the energy market will be subject to its regulation, and which will escape. It is clear, however, that there will be interplay, and that issues in this area will continue to be complicated and fact-specific. There is a possibility that, in some cases, the result may be inconsistent with not only the realities of the utility industry, but also with the energy policies of the individual States and the FERC. S. 621 would eliminate the tension between the 1935 Act and developments in the industry, by largely eliminating the regulatory framework of the statute. 13 This regulation includes compliance with the integration requirements of section 11 (discussed above). 14 See, e.g., Norstar Energy L.P., SEC Staff No-Action Letter (Feb. 9, 1995); and Enron Power Marketing, Inc., SEC Staff No-Action Letter (Jan. 5, 1994). In contrast, the FERC considers power marketers to be utilities under section 201(e) of the Federal Power Act, and regulates them accordingly. Q.4. The SEC recently issued Rule 58, to allow public utility holding companies to acquire energy related subsidiaries without prior approval. With this new rule, holding companies will be better able to diversify and adapt to the changing landscape of the energy industry. In light of the SEC's continuing administrative actions, do you still recommend conditional repeal over administrative action to change PUHCA? Why? A.4. As the June 1995 report noted, the SEC has long recognized that the current regulatory system imposes significant costs, in direct administrative charges and foregone economies of scale and scope, that often cannot be justified in terms of benefits to utility investors and consumers. In many respects, developments in other Federal and State regulation and in the financial markets and the utility industry have created a pervasive system of investor and consumer protections that obviate the need for many of the specialized provisions of the 1935 Act. 15 As a result of that, the report concluded that the 1935 Act should be repealed, conditioned on preservation of some provisions which still continue to provide consumer protections. 16 Pending congressional action to either repeal or substantially amend the 1935 Act, the SEC staff proposed a number of administrative reforms in order to modernize and to simplify regulation, to reduce the delay inherent in administration of the 1935 Act, and to minimize regulatory overlap, in each case consistent with the purposes of and protections mandated by the 1935 Act. Rule 58, adopted by the SEC on February 14, 1997,17 was a major component of these administrative reform proposals. These reforms were intended as interim measures, and the SEC still believes that, pending legislative action, implementation of administrative reforms is appropriate. There are limits, however, to the extent to which the interpretation of the 1935 Act can be liberalized to accommodate changes in the industry, and some beneficial activities may be precluded. Moreover, only companies in registered holding company systems are subject to these limitations, while exempt holding companies and stand-alone utility companies can engage freely in various activities, including diversification into non-utility businesses, subject to any applicable State regulation. 18 Repeal of the diversification restrictions of the 1935 Act would level the competitive playing field. The SEC will streamline regulation wherever possible and appropriate, but it cannot repeal the 1935 Act through administrative action. Repeal is the exclusive province of Congress. Please let us know if further information is desired. 15 In the early 1980's, the SEC determined that the purposes of the 1935 Act had been achieved and recommended to Congress that the Act be repealed. 16 The 1995 report concluded that the 1935 Act continues to play a role in protecting energy consumers. Most importantly, the SEC can obtain, audit, and oversee a multi-state holding company system's books and records, particularly in regard to affiliate transactions. The staff therefore recommended that Congress repeal the statute and, at the same time, enact new provisions to ensure access to books and records required for the effective discharge of the FERC's and the States' regulatory responsibilities and to establish Federal audit authority and oversight of intrasystem transactions. 17 SEC Release No. 35-26667 (Feb. 14, 1997), 62 Fed. Reg. 7900 (Feb. 20, 1997). 18 See note 3 above. |