-------------------- BEGINNING OF PAGE #1 ------------------- TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U.S. SECURITIES AND EXCHANGE COMMISSION REGARDING THE REGULATION OF PUBLIC UTILITY HOLDING COMPANIES OCTOBER 13, 1995 EXECUTIVE SUMMARY The Public Utility Holding Company Act of 1935 ("1935 Act") was New Deal legislation that responded to problems that arose in the electric and gas industry in the early part of this century. Other forms of regulation adopted or enhanced over the past 60 years have made the 1935 Act increasingly redundant. At the same time, changes in the industry have brought into question the continuing relevance of the 1935 Act's monopoly-based scheme of regulation. In the summer of 1994, the Commission staff, at the direction of Chairman Arthur Levitt, undertook a study of the regulation of public-utility holding companies. The study culminated in a Report issued last June that proposed a range of legislative and administrative recommendations that, if adopted, would eliminate unnecessary regulatory burdens on public-utility holding company systems. Chairman Levitt testified on behalf of the Commission regarding the Report before these Subcommittees in August 1995. As Chairman Levitt stated then, the Commission has begun to implement many of the administrative measures recommended in the Report. At the same time, the Commission recommended, and continues to recommend, that Congress address the regulation of public-utility holding companies more comprehensively. Specifically, the SEC recommends that Congress consider the following legislative options: * repeal of the 1935 Act, accompanied by the creation of additional authority at the state and federal level for the continued protection of consumers through examination and oversight of transactions between or among affiliates of public-utility holding companies by the Federal Energy Regulatory Commission ("FERC"), and access to books and records by the FERC and the states; * outright repeal of the 1935 Act with no additional authority; and * broader exemptive authority for the SEC. To ensure the continuing protection of consumers pending development of full-scale competition in the utility industry, the Commission supports the first legislative option. Because certain provisions of the 1935 Act are still needed to protect consumers in multistate holding company systems, the Commission recommends that legislation to repeal the 1935 Act also provide necessary authority to state and federal regulators for the continued protection of energy consumers. --------------------------------------------------------------- TESTIMONY OF BARRY P. BARBASH, DIRECTOR DIVISION OF INVESTMENT MANAGEMENT U.S. SECURITIES AND EXCHANGE COMMISSION REGARDING THE REGULATION OF PUBLIC UTILITY HOLDING COMPANIES BEFORE THE SUBCOMMITTEES ON TELECOMMUNICATIONS AND FINANCE AND ENERGY AND POWER COMMITTEE ON COMMERCE U.S. HOUSE OF REPRESENTATIVES OCTOBER 13, 1995 Chairman Fields, Chairman Schaefer and Members of the Subcommittees: I appreciate this opportunity to testify before you, on behalf of the Securities and Exchange Commission (the "SEC"), regarding the regulation of public-utility holding companies. As you know, Chairman Arthur Levitt testified for the SEC on this issue before these Subcommittees last August. The SEC's position has not changed since that time. The following testimony summarizes the SEC's approach to this complex and important subject. I. INTRODUCTION In the summer of 1994, Chairman Arthur Levitt directed the staff of the SEC Division of Investment Management ("Division") to conduct, under the guidance of then-Commissioner Richard Roberts, a study of the Public Utility Holding Company Act of 1935 ("1935 Act") and the SEC regulations under the statute. The purpose of the study was to identify unnecessary and overlapping regulation, and also to recognize any features of the statute that might continue to have validity in regulating the modern electric and gas industries.-[1]- The Division consulted with numerous parties, reviewed thousands of pages of comments, and conducted a survey of state regulation. In the report on the study issued in June 1995 ("Report"), the Division concluded that, although many of the regulatory constraints imposed by the 1935 Act are outmoded, certain of its provisions afford sound and necessary consumer protections. Based on findings made during the study, the SEC has recommended, and continues to recommend, that Congress repeal the 1935 Act and enact measures to enable the Federal Energy Regulatory Commission ("FERC") and state regulators to continue to protect utility consumers. --------- FOOTNOTES --------- -[1]- Because the 1935 Act was enacted to address the problems that arose from multistate operations, and generally presumes that holding companies exempt from registration under the 1935 Act are adequately regulated by state and local authorities, the study focused primarily on the registered holding companies. Fifteen holding companies are currently registered under the 1935 Act; well over one hundred exempt holding companies operate in the electric and gas utility industry. Despite their small number, registered holding companies account for a significant portion of the energy utility resources in this country. In 1994, for example, registered public- utility holding companies owned over $117 billion of electric utility assets, nearly twenty percent of all assets owned by investor-owned electric utilities. -------------------- BEGINNING OF PAGE #3 ------------------- II. BACKGROUND The SEC administers the 1935 Act, which was New Deal legislation that responded to abuses that had developed in the electric and gas utility industry in the early part of this century.-[2]- A major part of the SEC's work in the years following passage of the 1935 Act involved the reorganization and simplification of existing utility holding companies in order to eliminate those abuses. In the early 1980s, the SEC evaluated the results of its administration of the 1935 Act and unanimously recommended that Congress repeal the statute.-[3]- The SEC based its recommendation primarily upon improvements in the state and federal regulation of public-utility holding companies and other related developments. The SEC noted that state regulation had expanded and strengthened since 1935. The SEC had enhanced its regulation of all issuers of securities, including utility holding companies, which had made many aspects of regulation under the 1935 Act redundant. In addition, institutional investors such as pension funds and insurance companies had become more sophisticated and demanded more detailed information from all issuers of securities than was previously available. Changes in the accounting profession and the investment banking industry also had provided investors and consumers with a range of protections unforeseen in 1935. Finally, the energy industry itself had changed substantially since 1935. The SEC concluded that the 1935 Act had accomplished its basic purpose and that its remaining provisions, to a large extent, either duplicated other state or federal regulation or otherwise were no longer necessary to prevent recurrence of the abuses that led to its enactment. Repeal legislation was not enacted, due in part to the continuing potential for abuse through the use of multistate holding company structures, related concerns about consumer protection, and the lack of consensus for change. The SEC continued its attempt to administer the 1935 Act flexibly, in order to respond to developments in the industry within the limits of the statute. In recent years, the pace of change in the utility industry has accelerated significantly. Congress has played a major role in the restructuring of the industry that is now under way and has created a number of statutory exceptions to the regulatory scheme under the 1935 Act. Over the course of its study, the Division 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. We received thousands of pages of comments in response --------- FOOTNOTES --------- -[2]- These abuses included inadequate disclosure of the financial position and earning power of holding companies, unsound accounting practices, excessive debt issuances and abusive affiliate transactions. See 1935 Act section 1(b), 15 U.S.C. Section 79a(b). -[3]- 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 (1982) (statement of SEC). -------------------- BEGINNING OF PAGE #4 ------------------- to a concept release issued in November 1994,-[4]- which sought comments on issues related to the need for public-utility holding company regulation under the 1935 Act and the status of other regulation. As part of its study, the Division collaborated with the National Association of Regulatory Utility Commissioners ("NARUC") on a survey of state regulation. With NARUC's assistance, the Division examined the coverage of current state regulation to identify any areas in which state regulation may not adequately protect consumer interests against the dangers of the remaining monopoly power of utilities. The responses to the survey revealed variations in regulation among the states.-[5]- State authority with respect to audits of holding companies, including those outside state borders, is particularly unclear.-[6]- The Division carefully considered issues related to consumer protections and competition in the electric and gas industries. There has clearly been significant progress toward a more competitive environment. The Energy Policy Act of 1992, Order 636 of the FERC, and the recent FERC notice of proposed rulemaking all represent significant steps to increase competition in the gas industry and in the generation and transmission segments of the electric industry. The Division concluded, however, that the utility industry has not yet evolved to the point where competitive forces serve the same function as, and eliminate the need for, regulation. The Report of the Division concluded that unconditional repeal of the 1935 Act would expose consumers to some risks against which the 1935 Act currently protects, and that a federal role in the regulation of some utility companies and their affiliates is still desirable. The Report's primary recommendation, therefore, is that Congress repeal the 1935 Act, but at the same time provide necessary authority relating to affiliate transactions, audits, and access to books and records, to state regulators and to the FERC. III. LEGISLATIVE RECOMMENDATIONS The Report recommends, and the SEC has endorsed, three legislative alternatives for the Congress to consider: (1) conditional repeal of the 1935 Act; (2) unconditional repeal of the 1935 Act; and (3) broader exemptive authority for the SEC under the 1935 Act. Each repeal option may require a transition --------- FOOTNOTES --------- -[4]- Request for Comments on Modernization of the Regulation of Public-Utility Holding Companies, Holding Co. Act Release No. 26153 (Nov. 2, 1994). -[5]- For example, at least three states do not regulate the issuance of securities by public utilities. Although 26 states indicated that they have no authority to regulate transactions between utilities and affiliated nonutility companies, some states have extensive statutory authority, such as Wisconsin, which has oversight of all transactions between a public utility, its holding company and any nonutility affiliates. A summary of responses to the state survey is included in the Report as Appendix A. -[6]- States that have yet to deal with multistate holding companies did not necessarily address the concerns raised by other states that do regulate out-of-state holding companies and their subsidiaries. -------------------- BEGINNING OF PAGE #5 ------------------- period to enable the states to adopt legislation and add any additional resources necessary to assume additional regulatory responsibilities occasioned by repeal of the 1935 Act.-[7]- Conditional Repeal The legislative option the SEC continues to prefer is conditional repeal of the 1935 Act, with an adequate transition period of at least one year. Under this option, Congress would repeal the 1935 Act while enacting legislation to provide state access to books and records and federal authority to oversee affiliate transactions and audit holding companies, in order to continue the 1935 Act's protection of energy consumers with respect to transactions among affiliates. The SEC favors conditional repeal of the 1935 Act for several reasons. As the Report indicates, regulation under the 1935 Act concerning the ability of holding company systems to issue securities, acquire other utilities, and acquire nonutility businesses is largely redundant in view of other existing regulation and controls imposed by the market. Certain provisions of the 1935 Act, though, continue to serve a useful purpose. Electric and gas utilities have historically functioned as monopolies whose rates are regulated by state authorities. Some regulators subject these rates to stricter scrutiny than others. A risk always exists that a monopoly, if left unguarded, could charge higher rates and use the additional funds to subsidize affiliated businesses to boost its competitive position in other markets ("cross-subsidization"). Therefore, as long as electric and gas utilities continue to function as monopolies, the need to protect against the cross-subsidization of nonutility operations will continue to exist. Given the increased sophistication of securities regulation and analysis by the public and private sectors, the best means of guarding against cross-subsidization is likely to be through audits of books and records and federal oversight of affiliate transactions. Our survey of state regulation revealed that the states may not have adequate authority to perform audit and review functions with respect to multistate holding companies, and the 1935 Act's provisions thus assist these states in protecting utility consumers. Former efforts to repeal the 1935 Act may have failed because they did not address this potential "regulatory gap" in consumer protection. Under the preferred legislative option, repeal would be conditioned on enactment of provisions that enable the FERC and state commissions to obtain access to holding company books and records needed for proper discharge of their regulatory responsibilities. Repeal would also be accompanied by continued federal authority, administered by the FERC, to audit companies and oversee affiliate transactions. Unconditional Repeal A second legislative option is unconditional repeal of the 1935 Act. Some interested parties argue that the states have the ability, if they choose to exercise it, to create regulatory structures sufficient to protect utility consumers in holding company systems. This option would also require a reasonable --------- FOOTNOTES --------- -[7]- Congress may also wish to consider a provision requiring the FERC to promulgate rules under the new legislation by the phase-in date, as well as a provision concerning the transfer of personnel to that agency. -------------------- BEGINNING OF PAGE #6 ------------------- transition period to give the states time to enact new legislation or add resources to meet the additional regulatory responsibilities that would accompany unconditional repeal of the 1935 Act. The SEC again recommends a transition period of at least one year. Broadened Exemptive Authority The third and final option is to provide the SEC with more authority to exempt holding company systems from the requirements of the 1935 Act.-[8]- If this legislative option is adopted, the SEC would likely develop a policy of granting exemptions with the consent of affected state regulators. This approach could lead to negotiations between companies and state regulators as to the conditions on which consent would be granted. Expanded exemptive authority would not, however, achieve the benefits of conditional or unconditional repeal of the 1935 Act. This option would not provide all the economic benefits of repeal or simplify the federal regulatory structure.-[9]- Further, this option would continue to enmesh the SEC in difficult issues of energy policy. IV. ADMINISTRATIVE REFORMS The Report presented a number of significant proposals for administrative reform pending legislative action. These administrative reforms could eliminate nearly two-thirds of the filings under the 1935 Act, and at the same time allow the SEC to redirect its focus to areas where federal regulation is needed to --------- FOOTNOTES --------- -[8]- The Commission's current exemptive authority is considerably narrower than its exemptive authority under some other federal securities laws. See, e.g., section 6(c) of the Investment Company Act of 1940, 15 U.S.C. Section 80a-6(c) (granting the Commission the authority by rule or order to exempt any person or transactions from any provision or rule if the exemption is necessary or appropriate in the public interest and consistent with the protection of investors); section 206A of the Investment Advisers Act of 1940, 15 U.S.C. Section 80b-6a (same). -[9]- In the past, the SEC has testified before Congress with respect to concerns that arose after the decision by the U.S. Court of Appeals for the District of Columbia Circuit in Ohio Power v. Federal Energy Regulatory Commission, 954 F.2d 779 (D.C. Cir.), cert. denied, 113 S.Ct. 483 (1992). See Registered Holding Company Transactions: Hearing on The 1992 Ohio Power Decision Before the Subcomm. on Energy and Power of the House of Representatives Comm. on Energy and Commerce, 103d Cong., 2d Sess. 35-48 (1994) (testimony of Richard Y. Roberts, Commissioner, SEC). The legislative repeal options discussed above would eliminate the problem of conflicting SEC and FERC decisions that was the subject of that decision. Enhanced exemptive authority would not address such problems unless the SEC, through the exercise of its exemptive powers, were to cease issuing orders affecting the pricing of goods. -------------------- BEGINNING OF PAGE #7 ------------------- protect utility consumers.-[10]- Although these measures should provide some relief from the regulatory constraints of the 1935 Act, Congress may wish to address the statute more comprehensively. V. ADMINISTRATIVE RESOURCES The SEC's legislative recommendations raise the issue of resources. Currently, eighteen SEC employees are devoted to administration of the 1935 Act. Their work includes (1) analysis and disposition of requests for various transactions covered by the 1935 Act, (2) audits of holding company systems and related companies, and (3) drafting and implementing proposals for changes in SEC rules to reflect changes in the utility industry and in financial regulation. Repeal of the 1935 Act would not achieve great cost savings for the federal government, particularly if some of these responsibilities were carried out by the FERC. Augmented exemptive authority, on the other hand, could require greater resources, in view of the need to evaluate and implement broad requests for exemptive relief. * * * The SEC is committed to promoting the fairness, liquidity, and efficiency of the U.S. securities markets. It also takes seriously its duties to administer faithfully the letter and the spirit of the 1935 Act. By recommending conditional repeal of the 1935 Act as described in Chairman Levitt's testimony last August and in this testimony, the SEC hopes to reduce unnecessary regulatory burdens on America's energy industry while providing adequate protections for energy consumers. --------- FOOTNOTES --------- -[10]- For example, the Report recommends rule amendments to broaden exemptions for routine financings (see Holding Co. Act Release No. 26312 (June 20, 1995), 60 Fed. Reg. 33640 (June 28, 1995)) and to provide a new exemption for acquisition of interests in companies that engage in energy-related activities (see Holding Co. Act Release No. 26313 (June 20, 1995), 60 Fed. Reg. 33642 (June 28, 1995)). It also recommends changes in administration of the Act that would permit "shelf" approval of financing transactions, relax constraints on utility acquisitions, expand the scope of permitted nonutility activities and streamline the approval process for such transactions. The Report also recommends an increased focus upon auditing regulated companies and assisting state and local regulators in obtaining access to books, records and accounts.